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Debt Dynamics

April 2015

By Apryl Motley

Institutions partnering on residential housing projects with third-party developers must evaluate critical credit components of such transactions.

A room of their own? In decades past, most higher education students did not have this expectation of their housing on or off campus. Times certainly have changed. In fact, one of the most popular types of new campus housing is suite-style, which includes several bedrooms with private baths, along with generous common space for kitchen, living room, and more.

“We didn’t have the kind of housing students wanted,” says Dana Keith, associate vice president, financial affairs, at the University of Alabama (UA), Tuscaloosa. “They like having their own rooms; suite-style housing is what they wanted.” 

At the same time, says Sara Russell, director, municipal finance, for RBC Capital Markets: “A lot of institutions are faced with tightening constraints on their budgets, and it’s difficult to go to state legislatures for money to build housing.”

Student demand coupled with increased enrollment led the university to consider funding models that would make new housing available quickly, but cost-effectively—“a challenge that can be hard to overcome when you need to rely on state appropriations, the legislative process, and public sector unions,” notes Bob Shea, NACUBO’s senior fellow, finance and campus management. 

The need to finance student housing projects is evident, but the question is who will pay—when and how—and in what manner will this decision affect an institution’s balance sheet? According to a September 2014 report from Standard & Poor’s Rating Services, during the past three years, the number of its rated privatized student housing transactions has more than tripled.

“We have seen a huge increase in these kinds of transactions, where universities outsource housing to private developers,” says Jessica Wood, director, U.S. public finance, for Standard & Poor’s. “And we expect this trend to continue.”

For example, the University of Alabama, in 2008, opted to establish Ridgecrest Student Housing LLC, a nonprofit corporation, under the university’s 1831 Foundation, formed to transact business associated with providing housing at or near the UA campus. 

Similar concerns led to the University System of Georgia’s decision to enter into a public-private partnership (P3) with Corvias Campus Living. Under the agreement, Corvias plans to construct more than 3,753 new beds across seven of USG’s nine privatized campuses, and will be responsible for managing the operations of both the new beds and the 6,195 beds on these campuses.

“Many universities have a lot of capital constraints, combined with short- and long-term capital needs,” says Kurt Ehlers, managing director of Corvias Campus Living. “This creates a significant challenge for them, but a great opportunity to leverage the experience and financial resources of the private sector.” 

While dealing with myriad challenges on the financial front, institutions like UA and the University System of Georgia are almost simultaneously faced with modernizing aging student housing facilities or constructing new ones to remain competitive in the marketplace. According to the National Center for Education Statistics, “college enrollment is expected to set new records from fall 2012 through fall 2021. Between fall 2011 and fall 2021, enrollment is expected to increase by 13 percent.”

Read on to learn more about two prevalent models for funding, and essentially privatizing, new student housing: forming a nonprofit corporation or entering into a public-private partnership, both of which are considered off balance sheet transactions. Institutions should keep in mind, however, that rating agencies generally continue to consider such debt when evaluating the institutions’ overall ratings, cautions Shea. “Agencies look at the cash flows associated with student occupants, occupancy rates, and the projected housing demand now and in the future. They also consider relationships between and among the university, the foundation, the developer, and the property manager.” 

Catalysts for Coming to the Table

A series of factors usually prompts higher education institutions to consider off balance sheet transactions for housing construction. Chief among them, reiterates Keith, is the desire “to bring housing online as soon as possible.” For UA, that meant keeping up with enrollment that increased by more than 8,400 students, from fall 2003 to fall 2009. During this same period, the university issued debt to build two new on-campus residential facilities in 2005 and 2006. These were followed by the privatized student housing projects Ridgecrest East and West, in 2007, and Ridgecrest South, in 2009—all of which offer four-bedroom suites with private bedrooms.

While the need for more housing had been evident, the university had already issued debt for deferred maintenance and the expansion of academic, residential, parking, and athletic facilities. Keith notes that establishing the 1831 Foundation was identified as the optimal funding option for getting the best credit rating without adding another obligation to the university’s balance sheet.

In the case of USG, Ehlers says “a confluence of factors” led the administration to pursue a public-private partnership to fund construction of new student housing. One of those factors was the state’s limitation on the amount of debt institutions can undertake. 

While state support of institutions has decreased, Ehlers notes: “Increasing tuition was not a viable funding model.” Further, in the past, “housing had been a lower priority for higher education institutions, when compared to academic or athletic facilities that support recruitment. “As a result, the trend had been towards [constructing] one-off housing projects that would be underfunded, without programs for maintenance and modernization.” 

All these factors have served as catalysts for higher education institutions to pursue alternative funding models to fulfill their housing needs.

Details of the Deal

The manner in which such funding models would be structured was of great concern to both UA and USG. Neither institution wanted to undertake any agreement or partnership that had the potential to negatively impact its debt capacity and overall credit rating. Following are some of the institutions’ concerns and considerations:

“Under our model and approach, we have programmed out a plan over 65 years to replace all of the housing constructed as part of our partnerships,” he continues. “At the end of our partnerships, the average age of existing assets is 15 years. There’s always funding in place to replace, repair, and modernize the housing. At the end of the ground lease, the asset goes back to the university in great shape.”

Another difference in Corvias’ approach to typical P3s is that there are no break-even occupancy rates or guarantees built into their agreements. “We’re confident in our ability to build the right product for students and keep the housing full,” Ehlers says. “We believe that we can do that in a cost-effective way, and we worked with USG to set rents to keep units affordable.”

RBC’s Russell explains that student demand is quite important on the financing side as well. “Investors are interested in where the draw for students will come from; what do students say they want and need versus what’s being constructed?”

At UA, administration of the privatized facilities is handled in-house. “We serve as the manager for these residence halls,” Keith says. The university’s housing/facilities division manages operations for these new dorms, and UA charges the foundation a management fee for these services. From Keith’s perspective, this arrangement was a means of getting the best debt rating, because the debt issued for the new housing was an obligation of the foundation rather than of the university. UA’s current private student housing bond has an A- rating from S&P.

By the same token, Russell notes that, while there’s generally concern about the debt being part of the institution’s credit profile, “you have to go into the process knowing that the rating agencies are going to put the debt on your credit, which doesn’t have to be a bad thing.”

Credit Concerns

“Just because a transaction is off balance sheet doesn’t mean we consider it off-credit,” says Jessica A. Matsumori, a senior director at Standard & Poor’s.

This is the case, because for those privatized student-housing bonds that are rated, support from the underlying institution is one of the key credit characteristics that are evaluated in determining the rating. “While transactions may be off the university’s balance sheet, the transaction could receive an uplift in rating based on its relationship or connectivity with an underlying institution,” Standard & Poor’s Wood says. “If the housing wasn’t on, or associated with a campus, and benefitting from competitive advantage in terms of marketing and filling beds, those transactions wouldn’t be rated as highly.” 

S&P provides ratings that are reviewed annually, and the rating agency’s outlook period looks forward for two years. Certainly, evaluation of risks for the short- and long-term is part of what goes into the ratings.

For privatized student housing bonds, there’s always new construction risk and timing risk of a building not opening on time. “We look to see what contingency plans are in place for construction or budget delays, and for housing these students,” Wood says.

“In general, our rated universities have A/A+ credit ratings, while these transactions are typically rated in the BBB category (if they have a solid link to the sponsor institution), because there is considerable startup and construction risk,” Matsumori explains. Another key area of risk is cash flow based on projected rental income and occupancy rates, which are also among the key credit characteristics that go into ratings. “Expectations about occupancy and rental rates might not come to fruition,” Matsumori notes. 

“Typically, the security of the bond is nonrecourse to the sponsor institution, made up of net revenue [cash flow],” Wood says. “Revenue comes down to occupancy and rental rates, and the biggest pressure area is rental rates if students are not willing to pay a premium for newer, more modern housing. Further, if enrollment declines and there’s no first-fill provision, there could be pressure on occupancy.” However, from Wood’s perspective: “Another unknown is the relationship between the institution and the private developer. It could change.”

For instance, the pricing strategy is a key piece. According to Wood, “over the long-term, they could disagree on pricing strategies and levels of investment in deferred maintenance,” which is one of the areas reviewed when evaluating the financial projections for these transactions.

Despite the risks and credit concerns, Matsumori acknowledges: “Privatized student housing bonds could be the best option for some public institutions to complete projects quickly.

“It’s so difficult for them to do these kinds of projects on their own. They almost have to find other ways to do these projects; while private institutions often have more flexibility.”

As this funding option may continue to be the most viable, are there concerns about the long-term impact of privatized student housing bonds? RBC’s Russell doesn’t think so. “It’s not of great concern,” she says. “As long as certain budget controls are in place and institutions meet the ratings agencies’ threshold for debt coverage, these housing projects can be self-supporting assets. Most business officers understand that these are revenue-producing assets, and can be viable, ongoing self-supporting enterprises.” 

APRYL MOTLEY, Columbia, Md., covers higher education business issues for Business Officer.


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Neither institution wanted to undertake any agreement or partnership that had the potential to negatively impact its debt capacity and overall credit rating.