Campus Consolidation: revisiting the university investment thesis

Key takeaways:

Close proximity to universities has been highly desirable in the past and viewed as a sign of stability and a general risk mitigant and reason for optimism. However, changes brought about or expedited by the pandemic may outlast the virus and make the university investment thesis much more narrowly applicable.
Through July 2020, investment activity in markets more exposed to universities fell 49% compared to the same period in the prior year – this was 700 basis points lower than the national decline of 42%.
Over 63% of universities have adopted virtual learning solutions during the pandemic. Nearly a third (34%) decided to look past the pandemic and have class in person, while over a third of universities (37%) decided to shift instruction online, and about a quarter (26%) opted for a hybrid approach.
Prior to the pandemic, many of the roughly 4,000 degree-granting universities in the US were in a precarious financial condition already, as a result of high operating expenses, over-reliance on tuition and fees, and declining student populations. The pandemic shock is likely the start of the end for many universities.
The potential impact that a university might have on the local economy and property market is determined by the University-Specific Risk and the overall University Exposure.

Since the pandemic started, commercial property markets that have proportionally more exposure to university campuses have experienced more significant declines in market activity across all major property types when compared to those markets with less exposure. Through July 2020, metropolitan statistical areas (MSAs) with more exposure to universities experienced a year over year decline of 34% in number of completed transactions compared to the same period in 2019 – this was more than 400 basis points below the national decline during the same period, 29%. Additionally, the markets with higher proportion of university students also experienced a 49% decline in transaction volume compared to the same period in the prior year – this was 7pp lower than the national decline of 42%.

For decades, universities and other institutions of higher learning have been a core part of investment theses and a sign of market stability and growth. Along with hospitals, universities have been important components of growing and established markets, as they are key contributors to local economies – as they serve as centers of employment, innovation, culture, entertainment, and serve as population magnets for their local communities. Close proximity to universities has been highly desirable in the past and viewed as a sign of stability and a general risk mitigant and reason for optimism. However, changes brought about or expedited by the pandemic may outlast the virus and make the university investment thesis much more narrowly applicable. In this report we’ll look to answer the following questions:

How have universities responded to the pandemic?
Why does it pose such a long-term risk to universities?
What role do universities play in local economies and property markets?
What trends are emerging across property markets with different levels of university exposure?
In which markets do universities enhance or hinder the property investment thesis?

The start of the end for many universities

Amidst the chaos of the national health crisis and with the fall 2020 semester approaching, many university administrators were forced to decide whether it was going to be business as usual or a special start to the academic year in 2020. Nearly a third (34%) decided to look past the pandemic and have class in person, while over a third of universities (37%) decided to shift instruction online, and about a quarter (26%) opted for a hybrid approach.

The shift to online is not new, but the pandemic expedited its adoption, like the pandemic has done with so many other trends. This move to online might have helped to keep universities operating this semester, but it is likely the start of a longer-term shift in pricing power and perceived value of the universities’ product: education. The demonstration of wide availability and willing adoption by many universities of online learning is a threat to the old and more costly in-person education business model.

Prior to the pandemic, many of the roughly 4,000 degree-granting universities in the US were in a precarious financial condition already, as a result of high operating expenses, over-reliance on tuition and fees, and declining student populations – partially due to domestic demographics and partially due to the falling international student enrollment. While many of the big name schools have either large endowments or state support, there are thousands of universities that lack such support and need the tuition and fees revenue to balance their budgets. Those universities that are in stronger financial positions have also been able to tap the public markets for cheap financing, giving them more cash and a greater financial cushion over the less fortunate institutions.

With so many universities in vulnerable financial positions and the game-changing shift in pricing power spurred by the pandemic, the stage is set for the university landscape to consolidate. Barring some sort of major federal or state fiscal intervention, it is not a question of if, but when, US universities will see this consolidation. Some universities will fail, others will merge or be acquired, and others will look to monetize their assets and property through sales. And as this consolidation takes place, the property markets that house these institutions will be affected and fundamentally changed.

Recent property market trends

The pandemic has slowed property market transactions across the nation and across all property types – posing a significant challenge for price discovery. The MSAs that have higher relative student populations and more exposure to universities have generally seen even more significant drop offs in transaction activity than the national average – though given the sample size there is not sufficient support to say that the university exposure is the cause of this. The property types that have been most affected in these markets have been Multifamily and Retail – which trail the national trend by the most – and Office following close behind. Even though higher student populations appear to correlate with more severe declines in transaction activity for most property types, the Hospitality sector appears to be in relatively better shape in these markets than elsewhere. However, this is most likely a coincidence because larger population centers (e.g., gateway cities) that have more robust tourism and hospitality sectors generally are too big to have very large concentrations of students.

Revisiting the thesis: bolster or burden?

The presence of universities within a market is undeniably a good thing – both for the local economy and property market. However, if there is to be consolidation across universities, this presence should not be taken for granted. University closures will likely disrupt local markets – in a similar way that a large company bankruptcy or exit from a local market would have a lasting negative impact. The real threat of consolidation raises the question: In which markets do universities enhance or hinder the property investment thesis?

MSA University Risk = University Exposure * University-Specific Risk

To determine whether local universities will be a benefit or potential risk within a market, we look at two key factors. First, we look at the university exposure within the local market and economy; or in other words, how significant are the universities within this local economy? We estimate this using the size of the university student population compared to the surrounding population.

Second, we look at the university-specific risk, or the financial and operational vulnerability of the local universities within a MSA. For the university-specific risk, we borrow from a creative analysis by Professor Scott Galloway of New York University and team. In the analysis, Professor Galloway looks at 400+ US universities and assesses their relative positioning and likely outcomes post-COVID. The two key metrics calculated to do this are Value and Vulnerability. The Value metric “seeks to quantify each school’s value relative to its tuition cost.” The Vulnerability score “seeks to quantify a school’s vulnerability” to the pandemic by considering the school’s endowment size, student population, and percentage of international students. The analysis puts each school into one of four categories – which Professor Galloway describes best from his article:

“Thrive: The elite schools and those that offer strong value have an opportunity to emerge stronger as they consolidate the market, double down on exclusivity, and/or embrace big and small tech to increase the value via a decrease in cost per student.
Survive: Schools that will see demand destruction and lower revenue but will be fine, as they have the brand equity, credential-to-cost ratio, and/or endowments to weather the storm.
Struggle: Tier 2 schools with one or more comorbidities, such as high admit rates (anemic waiting lists), high tuition, or scant endowments.
Perish: Sodium pentathol cocktail of high admit rates, high tuition, low endowments, dependence on international students, and weak brand equity.”

We quantify the four categories, weight and aggregate these expected outcome scores for each MSA, and then combine this with the university exposure data for each MSA to make a relative comparison across markets.

Universities are key contributors to local economies and serve as a source of employment, education, training, culture, entertainment, and are an attraction for visitors and students alike. As such, universities play an important role in local commercial property markets across the US – as both owners and occupiers. Their portfolio mix differs from the national property mix. The chart below shows the general makeup of the commercial property across the US by property count (excluding land)

Unlike the national portfolio mix, universities in aggregate occupy a large portion of office space and have an outsized portion of public and semi-public property. While many universities do have large portfolios of owned property, not all do. For those that do own, 90% of their portfolios is either public and semi-public, multifamily, or office. This occupancy and ownership property mix data spans both public and private universities, and varies significantly when looking at individual universities.

We looked at 421 universities across 375 MSAs, with a combined total of 4.6 million in full-time enrollment. This sample represents approximately 10% of the US universities and covers roughly 28% of students. In our analysis, we compare the student population of the schools to the respective universities’ MSA populations to measure each MSA’s relative university exposure. Then we use Professor Scott Galloway and team’s assessment of individual universities’ vulnerabilities to determine the expected outcome for universities within each MSA. Finally, by combining each MSA’s university exposure and expected outcome, we identify those likely to be bolstered and burdened by universities.

When assessing different MSA’s exposures to local universities, it is important to consider the local population by age cohort. While the current college aged population (aged 19-24) is important to consider, the local pipeline of potential university students currently in primary and secondary school (K-12) is, too. The college aged population makes up 8% of the population on average across the MSAs assessed, while the K-12 population accounts for 25%. Universities in markets where the college aged population outnumbers the K-12 population, or where the gap between K-12 and college aged is narrow, will be more dependent on attracting students from outside the local market.

The scatter plot shows MSAs plotted by their college aged population (x-axis), K-12 population (y-axis), and colored by the assessed relative strength and value of their local universities (lighter color indicates weaker and more vulnerable local universities). Most MSAs have college aged populations between 5-10% and K-12 populations between 22-28%. However, there are many MSAs that have higher college aged populations and relatively lower K-12 populations; these are seen in the center and to the right and fall below the trend line. The reputation of these universities is crucial for survival, as their local demographics are less supportive, and they will need to be able to attract outside students.

A team led by Professor Scott Galloway of New York University assessed 400+ universities and categorized them as either Thrive, Survive, Struggle, or Perish. Categorizations were based on two key metrics, Value and Vulnerability, which considered value relative to cost and overall position to weather financial and operational stress. We quantified these categorizations, determined aggregate expected outcomes for multiple universities within a single MSA, and then rank ordered these expected university outcomes for each MSA. By comparing university exposure and expected university outcome we determine if the university exposure is likely to bolster or burden the local MSA’s property markets.

Data overview

In this report we leverage over 296,000 transactions of hospitality, industrial, multifamily, office, and retail transactions across 375 markets or MSAs. Each transaction occurred between January 2015 and July 2020, was greater than $500,000, and had more than 5,000 square feet (10,000 for multifamily). To observe differences in different MSAs, we grouped the MSAs by estimated university student population relative to total MSA population based on 2019 estimates from Census. The categories of MSAs by size include:

High Student: These are 24 MSAs that have larger student populations (approximated greater than or equal to 10% of total MSA population).
Low Student: These are 154 MSAs that have lower student populations (approximated less than 10% but greater than 0% of total MSA population).
Other: These are 197 MSAs that did not include either High Student or Low Student MSAs.
All: These are all 375 MSAs, including the MSAs in High Student, Low Student, and Other.

Data used in the report includes Reonomy property data, Census population data, university addresses from Department of Education, university schedule data from CollegeCrisis, and university scoring data from Professor Galloway’s analysis.