This little-known real estate investment can give your portfolio a better tax and income grade

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OUTSIDE THE BOX

When COVID-19 lockdowns sent college students home in 2020, many feared the pandemic would establish online learning as the new norm and significantly weaken the student-housing business.

In fact, while many students opted for online courses in 2020, they also decided to live in on- and off-campus housing. Since many had already signed leases for the full academic year, the student-housing market remained solid overall

Looking ahead, real-estate-industry experts project an auspicious 8% undergraduate enrollment-rate increase over the next decade. You’ll see early indications of these predictions playing out in the uptick in first-time, first-year-student enrollment, which increased by 4.2% — a gain of 13,700 students — in the spring of 2022, compared with a loss of about 11,800 enrollees a year earlier. Meanwhile, public four-year institutions reported a 10.8% increase in freshmen. 

Though all investments experience market fluctuations, the student-housing sector has historically shown less volatility than most. The minimal disturbance the market experienced during the earliest stage of the pandemic and the recent hearty increase in investor interest substantiate its steady nature.  

With a projected total of almost 20 million students enrolling in college by 2029, student housing remains an attractive investment opportunity now and into the future. 

Indirect vs. direct investment

Earlier in the pandemic, investment in private, fixed student housing plummeted from a seasonally adjusted annual rate of $4.51 billion in the fourth quarter of 2019 to $2.86 billion in the second quarter of 2021.

The pandemic drove many direct commercial real estate, or CRE, investors to reconsider the stresses of purchasing and managing a property on their own. Plus, direct investment in student housing can be a high-risk venture for someone with little to no real-estate investment and management experience. 

Since then, indirect investment opportunities including Real Estate Investment Trusts (REITs) and Delaware Statutory Trusts (DSTs) have become more enticing. 

The DST advantage

DSTs allow each investor to secure fractional ownership in a variety of CRE properties, including student housing. As an indirect investment avenue, a DST gives an investor the chance to easily invest in multiple properties and expand and stabilize a portfolio. 

Similar to DSTs, REITs allow individuals to invest in multiple property types through a diversified portfolio. While there are some privately traded REITs, most investors gravitate toward the publicly traded options, which can outperform the stock market in the long term but be equally unpredictable in performance. 

Meanwhile, you’ll enjoy the same tax shelters as with direct investment — ones you can’t access with REITs. DSTs provide the same income-tax shelters as direct ownership of real estate. As a general rule, this provides higher tax-sheltering potential compared with investments in REITs. Additionally, private real estate, which includes DSTs, does not trade on active exchanges, and so valuations move far less frequently as compared with publicly traded REITs.

DSTs also offer capital-gain deferment options. For example, if an investor sells a DST, that investor can purchase another commercial property of similar value and defer capital gains to the new investment by using a 1031 exchange or a like-kind exchange.

Benefits of student-housing DSTs

In addition to providing a tax-sheltered, passive, monthly revenue stream, a DST that includes investments in student housing, in particular, can provide other alluring benefits:

  • Potentially higher income return, occupancy rates and renter stability than conventional rental properties due to the economic stability of colleges and universities.
  • Historically high tenant demand.
  • Prompt, consistent payments from students who typically co-sign with parents.
  • Easy marketability within a captive audience. 

Student housing has also demonstrated stability and high rebound capacity, even amid “black swan” events like the COVID-19 pandemic. 

What to consider before you invest

Though a DST that includes student housing sounds promising, there are still considerations before you invest. For instance, if a DST sponsor pitches an opportunity in a college town, it is important to understand the balance of supply and demand in that market, as there are a finite number of students at each university, and it’s difficult to create demand in an oversupplied market.

You should also thoroughly evaluate a DST’s management and leasing expertise. Well-located properties on major campuses with strong leasing teams are often fully rented well in advance of the start of the school year. This is important because it may be difficult to lease any vacant units once classes are in session.

To identify whether or not a location is already oversaturated with housing options, scan local newspapers for apartment rental ads at the end of the school year, or watch for summer deals and discounts on student housing. 

You’ll also want to look for property characteristics that are attractive to the average college student:

  • Accommodations and attractions such as restaurants, shopping and movie theaters within walking distance of or in close proximity to the campus.
  • Rental units with multiple private rooms as well as communal spaces like a large living room for socializing.
  • Attractive amenities, such as outdoor spaces, modern appliances and smart-home technology.

If you plan to invest in student housing, consider diversifying your investments and select multiple properties sponsored by stable and reputable companies. That way, if one location experiences an unexpected slump, you can still draw income from another.

How to invest in student housing

It’s best to partner with a real-estate investment company that’s already well-versed in this specific sector. Direct investment in student housing can leave you vulnerable to the stresses of property management and maintenance as well as income loss due to inadequate experience in the sector. 

Working with a knowledgeable company ensures that experts have already thoroughly evaluated a potential investment. For instance, my company, Realized, considers the property’s competitive position compared with existing supply. We also examine the probability of new supply by anticipated delivery date, growth, development patterns, and physical and regulatory barriers pertaining to market entry. 

We then turn to the sponsor, comparing its net effective rent growth assumptions to independent submarket projections from Moody’s Analytics CRE. With context gained from submarket and location-specific analysis, as well as conversations with the sponsor, we are able to stress test financial projections. 

Furthermore, investing in a DST allows you a fractional ownership investment while leaving property management responsibilities with the trust. A DST sponsor, who identifies and acquires the property, arranges financing and property management. Once the sponsor fully packages a DST, it opens its offer to accredited investors. This type of partnership offers a variety of benefits:

  • Pools resources with other investors, allowing you to buy into properties that might otherwise be unaffordable.
  • Allows income to pass through to the your individual tax return so it isn’t also taxed on the corporate level.
  • Offers the possibility for entry or exit as a 1031 exchange, granting investors the ability to defer capital-gain taxes if they reinvest in a like-kind property.

Whether you choose to invest in a DST, REIT or private venture, an investment that banks on a continued and growing interest in higher education offers one of the most reliable CRE investment revenue streams available.

Full disclosure: The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.

Drew Reynolds is chief investment officer at Realized, a real-estate consulting firm in Austin, Texas.

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