Jlp development consultancy
Astute site selection • meticulous due diligence • risk management • value engineering • efficient and transparent reporting • asset management
Wellgate House, 200 Cowgate, Edinburgh
Draft Investors Pack
Student Accommodation Investment
The further and higher education sector is significant in the UK and is expanding rapidly and has not been adversely affected by the current economic climate. There is a continuing shortage of good quality student accommodation and the fundamental and ongoing supply and demand imbalance continues to drive exceptional rental growth with rental increases outperforming every other property sector. The student market is therefore uniquely positioned to produce strong rental growth even in difficult economic times. Student accommodation is the best performing property rental sector and has outperformed rental growth in all other property sectors over the short, medium, and longer term. It has emerged as a counter cyclical asset class with relatively stable and tangible demand and income projections. The business model of strong rental growth, low voids, and high occupancy is attractive to investors.
Edinburgh typifies this supply and demand imbalance with only 1,000 corporate purpose built beds for 45,000 full time students, growing to 51,000 by 2012. Edinburgh University alone has over 22,000 full time students and is ranked 6th in the UK and 23rd in the world (Times 2008). As a market, Edinburgh was ranked #1 location for student investment outside of London (Knight Frank 2008) and the summer festival letting adds a further attractive income opportunity outwith term time. Such supply / demand imbalance in Edinburgh should continue to result in significant rental growth in the student sector.
The corporate market is underdeveloped with an arid development pipeline meaning that the student housing market in Edinburgh will remain a long way from saturation for the foreseeable future. This will lead to high occupancy levels, outperforming rental increases, and continued demand for well located investment product.
Student rents for the forthcoming 2009 academic year range from £92 to £103 per week for institutionally run stock, and from £130 to £145 per week for private halls. Private studios command from £170 to £185 per week. Occupancy levels in both institutional and private sectors are effectively 100%.
The rents proposed for Wellgate House are in accordance with market evidence, starting from £130 per week for the ensuite rooms in cluster flats and from £180 per week for the studios. There are also 3 mezzanine studios with spectacular roof top views which are being priced at a £210 per week premium. Term time tenancies will be 43 weeks in line with the rest of the private market. Conservative rental increases have been modelled at 3% per annum, whilst market evidence indicates that higher rates of increase are being achieved.
Wellgate House is currently a 16,687 sq ft office building located in the heart of the Old Town on the Cowgate. Close to both the Royal Mile and the Grassmarket, it is ideally located in an area popular with students and only minutes away from Edinburgh University’s Old College buildings and Pleasance Sports Centre. Subject to receipt of planning, the building will be converted to provide 44 ensuite bedrooms arranged in 4 and 6 bed cluster flats and 15 studios, including 3 with mezzanine areas on the roof offering exceptional views across Edinburgh.
Valuers are currently adopting yields for prime Edinburgh city centre purpose built student properties of circa 6.25% - 6.75%, although there has been little if any recent and relevant transactional evidence. Wellgate House is not only a prime location but is a manageable lot size given the current state of the investment market, so should justify at least a 6.5% yield. The envisaged end value of the property is £5.9m. The yield could soften to 8.59% before the project fell to break even point.
Most if not all the negative sentiment has already been factored into investment values in this sector and there is little risk of oversupply suppressing rental growth. The student housing sector in Edinburgh therefore seems set to outperform in terms of both increasing income and capital growth driven by future yield compression.
Based upon initial budget cost planning and financial appraisal, the Wellgate House scheme is valued at £5.9m and can be delivered in time for the 2011 academic year. Total development costs are budgeted at £4.540m (£272 per sq ft), with an equity requirement of £1.64m, delivering an NAV uplift of £1,360,219 – a 30% Profit on Cost or 83% Return on Equity. Year 1 income represents 9.98% of the total development cost, which represents an attractive income yield.
The redevelopment of Wellgate House offers investors the opportunity to participate in the anticipated further out performance of rents in the student sector; and benefit from capital growth as and when yield compression returns to the market. At a time when development finance is hard to obtain in a bare debt market, investors can secure higher returns by investing in developing student accommodation. With limited opportunity to buy income-producing assets, participation in the development phase will generate higher returns than a dry investment purchase (9.98% on this occasion).
Whilst we are not calling the bottom of the market, most if not all of the negative sentiment has already been factored into investment values in this sector and the market seems to be bottoming out, and we now envisage a progressive firming of yields allowing investors to capitalise on yield compression. JLP believes that the timing of this acquisition at or near the bottom of the market cycle provides an ideal opportunity not only to deliver an immediate return, but to capitalise on the onset of improving market conditions and valuation improvements over the next 12 – 24 months. With tenant demand for the product being strong and continuing for the foreseeable future, rental values and future rental growth over and above inflation is secured. As a result there is no need to price in any risk of falling rents or rising voids for this product. The Wellgate House location is a prime location for student letting; there is little risk of oversupply in the market suppressing rental growth; and this investment therefore seems set to outperform in terms of both increasing net operating income and benefiting from capital growth driven by yield compression.
With the proposed leverage on this transaction set at 65% LTV, equity of £1.64m will be required to complete the development phase. Thereafter the development will be self financing with all operating costs comfortably covered by rental income and an operating profit of £310,059 pa at 2009 prices (70% of gross income) being delivered to service debt and fund dividends.
Equity or Joint Venture partners are going to be sought to provide the equity investment required, with there being a range of potential exit routes from a sale of the property with the benefit of planning consent through to managing the asset as a direct let property.
JLP will be development manager and asset manager for the development and will be co-investing in the venture, ensuring that the mangers’ interests are fully aligned to those of the investors.