Big Value And Yields Up To 7% In This Real Estate Niche

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 SP 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

)

.

Flickr/StuSeeger

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.

Valuations

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.