For developers of campus housing, the corks are going back on the champagne bottles.
Shares of EdR (NYSE: EDR) (formerly known as Educational Realty Trust), Campus Crest Communities (NYSE: CCG) and American Campus Communities (NYSE: ACC) have fallen 15% to 40% this year, at a time when the S&P 500 Index has risen more than 20%.
What went wrong? Slowing college enrollment trends, sector overbuilding, and an escalation in transaction prices for new properties that has led to lower returns on investment.
Investors are now questioning whether it's smart to buy these stocks. And if so, which one stands out? To answer that question, we can look at a range of financial metrics.
The Enrollment Reversal
This had been something of a "no-brainer" asset class. Many colleges have chronic housing shortages and are increasingly look to private developers to help fill the gap. That trend remains in place.
But another factor, an expectation of ever-rising enrollment trends, isn't panning out.
"While most industry estimates have enrollment growing by 1% through 2020, growth has been more flat and we expect a slight decrease through 2017 based on demographics. We note though that there is a slight dip in the prime college-age population based on U.S. live birth data through 2017," note analysts at Merrill Lynch.
College enrollment spikes when the economy is in a recession as fewer alternatives exist for 18-year-olds, but as the economy improves and unemployment falls, some prospective students elect to enter the workforce instead.
And for an industry that delivered a record 50,000 new beds in 2013 (with plans for almost as many new beds in 2014) according to Axiometrics, the notion of declining enrollment is an unwelcome change in the demand picture.
Another stat that has troubled the industry: "The number of students living at home has dramatically increased from 30% in 2010-2011 to 39% in 2011-2012, and most recently to 48% in 2012-2013 for four-year universities," according to Sallie Mae (Nasdaq: SLM).
|Florida State University is one of many U.S. colleges experiencing a student housing shortage.|
You can see the net result of too many beds chasing too few new students in the industry metrics. For example, at American Campus Communities, revenue per room is now growing less than 2% (due to slower rent hikes and rising occupancy rates). Yet the company's expenses per room are rising at a 5% to 6% pace. The net result: The company's net operating interest margin fell from 55.3% in the second quarter of 2011 to 54.4% a year later to a recent 52.3%. (Second-quarter results are more meaningful than recently released third-quarter results, which represent the slow summer period.)
Using this measure, EdR's trends have been only modestly negative, while Campus Crest Communities' net operating interest margin has been rising, as that firm has done a better job of managing expenses and occupancy rates.
To be sure, the need for supplemental housing will remain, and these companies aren't headed for tough times. But the recent period of overbuilding could lead to occupancy pressures on some campuses. To guard against that, these firms try to buy or build housing as close to campus as possible, which helps support occupancy rates.
By this measure, EdR comes out on top, with a median distance from campus of just one tenth of a mile. CCG and ACC have a median of around half a mile.
Against this tougher industry backdrop, share prices have come down in recent quarters. This group has traded, on average, for 17 times funds from operations (FFO) over the past 10 years, according to Merrill Lynch. That metric peaked at 21.8 in 2011, and the industry average now stands at around 13.5. Campus Crest, with a 2013 FFO multiple of around 10, is the most inexpensive stock in the group.
Falling share prices have also helped boost the dividend yield for these firms. And whereas they used to trade at a premium to projected net asset value (NAV), they now trade at discounts to NAV, making them certifiable bargains.
Should you be concerned that these companies intend to add a lot more beds in 2014? Not necessarily. The growth is coming at college campuses that still have the most severe housing shortages at schools such as Florida State University and Pennsylvania State University. But it is fair to question whether this industry can keep growing at a steady pace in 2015 and beyond.
And that's why dividend yields matter. You need to assume that long-term dividend growth will be moderate at best. As a result, Campus Crest's 7.3% current yield makes this the stock to own in the sector. The fact that all three trade below NAV indicates that the froth is truly gone from this sector.
Risks to Consider: As these are income-producing stocks, rising interest rates could diminish their appeal, though that process has already been underway in 2013.
Action to Take --> Although these campus real estate investment trusts are targeting the same market niche, their profit margins, growth rates and dividend yields have diverged. Campus Crest appears to be the best value of the bunch.