Summary

The last year has seen purpose-built student accommodation (PBSA) confronted by a stream of challenges in the face of the pandemic. We look at how the use of short-term income guarantees, usually seen in forward funding arrangements, has helped the transaction market continue in the face of adversity.

Impact of the pandemic

Over recent years PBSA has cemented its place as a strong alternative asset class, outperforming its competitors and becoming a much sought-after sector, particularly for overseas investors.

However, for much of the last year in England and Wales, students in universities and other higher education institutions have only been permitted to attend in-person teaching for courses such as medicine, which require specialist equipment and facilities. All other students have continued to learn remotely and they have been advised by the government not to travel between university accommodation and home.

As a result, some universities have provided refunds to students in their own accommodation, and the Minister of State for Universities has written an open letter to students urging providers to grant refunds.

The pandemic has clearly presented a unique but short-term challenge as the forecasted increase in overseas students and the demand for accommodation present good long-term prospects for the sector.  This has led to many transactions over the last year proceeding on the basis that the seller guarantees the income for this academic year after which it is anticipated that income levels will return to normal.

Types of rent guarantee

The most complete form of rent guarantee would see the seller agree to underwrite the whole of the expected income for the relevant academic year.  A middle ground would be to share an element of the risk, where the parties may agree a “top-slice” guarantee, the buyer taking the risk on the remaining income not being achieved.

The use of escrow agents to hold the guaranteed sum is common where there is not sufficient covenant strength. Agreeing which party covers the costs of a third party escrow agent should be considered upfront, particularly where withdrawals from the account are to be made frequently.

Reconciliations and releases can be done as required (usually at the end of each term) and are often linked to the payment dates in the assured shorthold tenancies under which the students occupy. Mechanisms to deal with disputes and evidence of income calculations at each reconciliation are essential elements of any rent guarantee.

Refunds

Although PBSA providers have been encouraged by the government to grant refunds, there is no legislation in England and Wales requiring them to do so (the position in Scotland is different). Despite this many providers have moved to grant some level of refunds but many have not.

The parties therefore need to negotiate a mechanism which clearly captures where it is reasonable for refunds to be taken into account in calculating rent guarantee reconciliations. Factors such as the buyer’s position, the local or national market, government guidance and the property manager’s advice may be relevant.

Types of income

Income from PBSA doesn’t always just comprise rent from students of course; the rent guarantee should be clear as to any ancillary income such as commercial areas, summer lettings, and services such as laundry provision. Sellers in particular may be concerned with whether insurance proceeds in the event of property damage should also be included in the income calculation.  Buyers may want to consider whether any council tax charges for unlet rooms (where an exemption isn’t available) should be deducted from income.

It should also be agreed whether the seller is to underwrite any nomination agreements which are in place. Careful consideration of the underlying arrangement with the university or education institution in these circumstances is required, as well as consideration of whether the arrangement already provides for any top-ups for bad debts or void rooms.

Letting obligations

The PBSA operator model continues to dominate, with key players such as CRM, Fresh and Homes for Students continuing to provide property management services for owners. Sellers should ensure that each rent guarantee is tailored to the buyer’s particular operating model, requiring the buyer to procure that the property manager maximises income in line with their established business plan for the particular property. A well-advised seller will also want to make sure that an incoming buyer with other sites in the same location can’t refer students to other properties in its portfolio and take advantage of the guarantee to cover voids.

Good faith clauses can also be helpful here. However, the challenges that apply to the enforceability of such clauses should be borne in mind when considering what this is to achieve in the particular circumstances, as these are generally interpreted narrowly.

Final thoughts

There are as many different types of guarantee as there are types of PBSA. Each guarantee will be particular not only to the transaction in question, but also to each market. Careful consideration of the property and its position in the local market at a university or city level is required. There is one thing which remains consistent, which is that the UK’s reputation for world-class education, the weakened pound and undersupply of accommodation will all continue to secure PBSA’s place as an attractive asset class.