U.S. Markets closed

This May Be The Safest Way To Profit From the "Renter Nation"

David Sterman

Although many are familiar with the high costs associated with college, few are aware of a growing opportunity to profit from this area.

Thanks to the robust post-World War II economic boom, newly flush parents sought to send their kids off to college to better compete in that era's dynamic workforce. A full 45% of U.S. high school graduates were enrolled in college by 1960, according to the American College Testing Program. 

Half a century later, that figure is now a stunning 70%. College admissions officers can pick and choose the best and brightest candidates, limited only by their ability to find housing and space for all those students.

Indeed, on many college campuses, landing a spot in a dorm can be challenging for upperclassmen. As many of these students go off-campus, a group of real estate investment trusts (REITs) have been meeting the challenge, building new housing facilities right on the outskirts of campuses.

My colleague Carla Pasternak recently highlighted new investment opportunities in the apartment REIT sector resulting from the growing imbalance between supply and demand for rental units.

She calls this growing trend "Renter Nation."

I've found three REITS that are capitalizing on this trend. American Campus Communities (ACC), Campus Crest Communities (CCG) and Education Realty Trust (EDR) now control roughly 6% of the nation's total off-campus housing market. In a fast-consolidating industry, that market share is poised to keep growing.

Take industry leader American Campus, for example. The company owned roughly $500 million in properties in 2005, but thanks to a series of tuck-in acquisitions, that asset base now exceeds $5 billion. Of course, those acquisitions have managed to soak up the company's free cash flow, so American Campus hasn't been able to boost its dividend in that time. The payout has remained constant at $1.35 a share (equating to a 3% yield) for seven straight years.

That frozen payout has created a bit of a conundrum for investors. American Campus is generally seen as the industry's strongest operator: 75% of its buildings are within a half-mile (or a 10-minute walk) from campus, compared with a 60% rate for its publicly-traded peers. This enables American Campus to charge slightly higher rents. Yet the middling yield isn't the best of the pack: Education Realty offers a 3.8% yield while Campus Crest offers a more enticing 4.8% dividend yield.

Stability and growth
Although dividend yields in the 3% to 5% range are merely acceptable but not robust, these REITs offer another pair of virtues that separate them from the rest of the REIT crowd. First, these firms can count on high occupancy rates, thanks to the steady enrollment levels at major universities. (American Campus has a solid 95% occupancy rate while Education Realty and Campus Crest have 90% occupancy rates.)

Indeed, these REITs tend to mostly focus on massive state college campuses such as the University of Texas or Arizona State, and these public colleges continue to attract more applicants thanks to lower tuition rates than private colleges.

These REITs also have a clear path to growth. The top 10 off-campus real estate firms control just 9% of the market, and a clear consolidation trend is under way. The three publicly traded REITs have relatively low costs of capital, which better positions them to snap up rival properties. Moreover, the "REITs have scale and operating efficiencies, particularly from savings on Internet advertising and marketing efforts," note analysts at Merrill Lynch. American Campus has been especially aggressive recently in terms of acquisitions, which explains why revenue is expected to grow nearly 50% this year to around $660 million.

Although American Campus is "best-in-class" in this sector in terms of size, occupancy rates and campus proximity, investors may also want to check out the higher-yielding Campus Crest Communities. 

The company is in the midst of a multistage acquisition of rival Copper Beech Investment that will roughly double Campus Crest's portfolio of assets within a few years. The deal should generate solid growth in cash flow per share, and the current dividend could rise to 80 or 85 cents a share by 2015, according to management. That would equate to a yield approaching 6%, which is quite impressive when you note the low-risk business model of student housing.

For that matter, analysts at UBS think that industry leader American Campus is also poised for a dividend hike, to $1.85 a share by 2014, which equates to a dividend yield exceeding 4%.

Risks to Consider: My colleague Michael Vodicka recently took note of the potential for severe distress in the student loan market, which could eventually lead to a drop in student enrollments. As another risk factor, these REITs are rolling up the industry thanks to very low costs of capital, though rising rates would make it harder to gain market share through further acquisitions.

Action to Take --> These campus REITs offer an easy way to generate income from a steady and growing investment niche. Yet many people in Renter Nation are looking to become landlords themselves. If you live near a college campus, then it pays to determine the borrowing costs and cash-flow yields that such an investment can generate. In an era of rock-bottom lending rates, the payback on these kinds of investments has never been more compelling.

Related Articles