With its high reliance on in-person operations, the privatized student housing sector was among the hardest hit during the COVID-19 pandemic. Operating pressures were exacerbated by the limited scope of these entities, as revenues are almost entirely from rents associated with student housing properties. While the operations of colleges and universities were challenged, with an average 10%-15% reliance on auxiliary revenues prior to the pandemic (including revenue streams such as housing, athletics, and bookstore revenues), those institutions had some flexibility to cover their revenue losses and benefit from relatively stronger financial resources. In comparison, most privatized student housing projects were structured with limited capacity to build their financial resources through ongoing operations, usually reporting just above their covenanted debt service coverage every year. Therefore, when occupancy drops significantly, most projects have very little in reserve. As a result, the rating pressures on these projects were material during the pandemic, depending on the specific circumstance of each project--including its occupancy trend, ability to meet required debt service payments through operations, support from the associated college or university, and the use and maintenance of reserve funds. S&P Global Ratings saw a small number of projects dip into their debt service reserve fund (typically used as a last resort) to make their stipulated payments; all are now rated in the 'B' category.

As the higher education sector returns to close to pre-pandemic operations, with students fully on campus and minimal to no de-densification or isolation space requirements for housing, we expect fall 2022-fiscal 2023 operations for these student housing projects will return to some form of normalcy. However, the rating distribution is unlikely to rebound to pre-pandemic levels in the near term, as it will take time for projects to recoup their losses and grow reserve levels after a year or longer of reduced occupancies. Many projects used their reserves to meet their debt service or expense needs during the pressured rental environment and some sponsor universities are now expecting to be repaid for the extraordinary support they provided during the pandemic. Projects that drew on their debt service reserve funds will need to replenish these funds, while most projects will need to deal with lower or no contributions made to the repair and replacement or maintenance funds during this time of financial pressure. Notably, as crisis events often do, the pandemic provided additional information about the degree of linkage between the projects and their associated universities, based on the willingness and ability of the universities to support these projects in a troubled time. We saw that projects with solid relationships with sponsor institutions that had the financial capacity to support them generally came out of the pandemic stronger than others. While most projects' bonds are legally non-recourse to the sponsor institutions, the fact that close to 50% of the rated projects received financial support demonstrates their strategic importance to higher education institutions.

Rating Distribution And Characteristics

Sector's rating distribution shifts downward, highlighting a "new normal" of recognized vulnerability

While most student housing projects have emerged from acute pandemic pressures and restrictions, the lingering effects remain. As of September 2022, 70% of projects have a stable outlook after a full year of negative outlooks across privatized student housing ratings. However, the stable outlook came at the price of downgraded ratings for 28% of those, representing a new normal of recognized vulnerability across this sub-sector following sudden closures, reduced revenues, rental reimbursements, and an unprecedented level of reliance on external support or reserves. Additionally, while universities provided support in some cases, they were also sources of restrictions--for example, mandating reserved units for quarantine and reduced occupancy for de-densification--limiting the potential project revenue.

Given this long arc of pandemic recovery, we've seen the sector's rating distribution shift downward--only 28% of privatized student housing projects were rated 'BBB-' as of Sept. 30, 2022, compared with 57% at the start of the pandemic (see charts 2 and 3). The shift was driven by 20 ratings being lowered across the rating spectrum since March 25, 2020. Of those, most downgrades occurred within the first year of the pandemic (76%), with one project (Foundation for Indiana University of Pennsylvania Phase II) seeing two consecutive years of downgrades. At the same time, 25 projects retained their pre-pandemic rating during the past two years. Of those, 88% have a stable outlook, while 12% remain on negative outlook. During the same period, we withdrew our rating on the debt of 18 projects: Most rating withdrawals followed the university's purchase of the project's debt, while three projects defaulted on their debt.

Chart 2

Chart 3

Five projects successfully opened during the last two years, with one of them opening in fall 2021 (see table 1), while one rated project remains under construction at this time. Despite pandemic-related pressures, including rising expenses and supply shortages, these projects generally opened on time and within budget. However, while all but one opened with more than 90% occupancy in fall 2021, only two opened at or above 95% occupancy--the pre-pandemic market standard. One project remains under construction at this time and was newly rated during the pandemic. Four of the five recently opened projects expect to exceed this occupancy threshold in fall 2022 with rates of between 97% and 100%.

Table 1

Of the 14 projects whose debt currently maintains a negative outlook, 64% are speculative-grade and generally have yet to regain some equilibrium after two years of pressured operations. These ongoing challenges have manifested as a median fall 2021 occupancy rate of 81% for projects with a negative outlook compared with a 95% median occupancy rate for projects with a stable outlook; and those projects on a negative outlook are barely meeting or are falling short of the standard 1.2x debt service covenant. While 50% of these projects with a negative outlook have used some form of external support or reserves, we anticipate a true recovery under their own operations will take longer to materialize.

Table 2

Occupancy: Rates Improve, But Remain Below Pre-Pandemic Levels

While occupancy rates improved significantly from fall 2020 to fall 2021, general demand in the sector did not return to pre-pandemic levels. Although 24% of projects experienced fall 2020 occupancy rates that were less than 50%, by fall 2021 all but one project, Beech International LLC, opened at more than 50% occupancy (see chart 4). Based on preliminary information available for fall 2022, we note that more projects are posting occupancy levels that are closer to fall 2019 levels. Few colleges and universities maintain de-densification requirements or more than a handful of reserved quarantine units, with expectations that those restrictions will be lifted in the coming year, making more units available for rent.

Chart 4

Overall, median occupancy for rated projects rose to 92% for fall 2021, an increase from 71% in fall 2020 but still lower than the pre-pandemic level of 98% in fall 2019. However, occupancy remains pressured at lower rating levels and for projects with a negative outlook, as exemplified by a median occupancy rate in fall 2021 of 83% for projects rated below the 'BB' category. We expect further recovery in fall 2022, driven by a full return to campus and a significant reduction of de-densification efforts, though some projects may still see pressured occupancy rates, given a continuation of pre-existing enrollment pressures in the higher education industry associated with factors such as demographic challenges and high competition. A true replenishment of financial reserves and operations to pre-pandemic levels of debts service covenant compliance will require both strong and sustained occupancy. Initial reporting from about 40% of projects across rating categories places the median expected occupancy rate for fall 2022 at a further improved 96%, with only four reporting projects in this small sample size with occupancies of less than 90%.

Finances: Debt Service Coverage Levels Start To Recover

The financial pressures from the pandemic started reflecting in projects' debt service coverage levels in fiscal 2020, with refunds issued by most housing projects in spring 2020. As a result, 30% of rated projects (excluding those that used capitalized interest to make debt service payments) reported debt service coverage of less than 1.2x in fiscal 2020 (see chart 5). This ratio increased to 39% in fiscal 2021 due to low occupancy levels in the fall semester. As occupancy partly recovered in fall 2021, fiscal 2022 coverage levels have improved (based on our discussions with issuers and on draft financials), with projects expecting coverage below 1.2x falling to 21%. Notably, the number of projects reporting debt service coverage of more than 1.5x remained stable during the past three fiscal years at eight projects. The list of projects that maintained coverage at or above 1.5x also shifted, with half of the projects above the threshold in fiscal 2020 dropping below it in fiscal 2021 to between 1.2x and 1.5x coverage--although three of the four projects expect coverage will increase to more than 1.5x in fiscal 2022. While operating pressures continued in fiscal 2022 due to lower occupancy and reduced support from the associated institutions compared to the past two fiscal years, we expect a higher number of projects will return to debt service coverage of 1.2x or higher in fiscal 2023 as occupancy recovers to pre-pandemic levels. After a period of struggle to make their required debt service payments, we expect a slow financial recovery for most student housing projects as they rebuild their financial reserves and manage maintenance costs after a period of limited or no contribution to their maintenance or repair and replacement funds.

Chart 5

Many projects received university support despite lack of legal mandates, highlighting the importance of relationships with sponsor institutions

Nearly 50% of the rated projects that maintained investment-grade ratings during the pandemic were able to pay debt service without requiring extraordinary external support, while almost all the remaining projects received support from their associated higher education institution (see chart 6). Several of these investment-grade projects maintain legal agreements with their associated institutions since inception that mandate extraordinary support, such as occupancy guarantee agreements and first-fill agreements. A high 76% of 'BB' category projects (excluding those using capitalized interest funds) received university support, none of which were under legally mandated agreements. In these instances, there was no legal requirement for the sponsor institution to provide any financial or other assistance; the schools did so given the strategic importance of the project to their campus. Two projects in the 'B' category received some form of university support to meet their obligations in the last two years. Of note, we saw some projects associated with sponsor institutions that faced financial pressures of their own during the pandemic suffer despite a strong strategic relationship, highlighting the importance of both the "willingness" and the "ability" of the related institution to support in such relationships.

Several speculative-grade projects used reserve draws to meet debt service payments

Only three rated projects had to resort to drawing from their debt service reserve funds to meet their annual debt service payments during the pandemic, all of which are in the 'B' rating category. We expect that these projects will continue to experience rating pressure due to their limited capacity to replenish the debt service reserve funds with operations. Most projects that used other reserve draws (apart from the debt service reserve fund) have ratings in the 'BB' category. Only one investment-grade project needed to use such reserve funds during the pandemic. Conversely, nine of the 10 projects that made debt service payments solely from operations without the need for any external support (i.e., university support or reserve draws) maintain investment-grade ratings.

Chart 6

What We Are Watching

Demand and occupancy

We believe demand has generally improved in fall 2022 as students are eager to be on campus and risks associated with the pandemic have decreased. While final occupancy rates are not yet available for all of our rated projects, we expect that most projects will see notable improvement from recent years.

Return to pre-pandemic reserve levels?

Most privatized student housing projects do not maintain substantial reserves beyond a debt service reserve fund, so the necessity for some projects to tap into their reserves during the pandemic had a significant negative influence on their available resources. We expect that it could take some time for projects to replenish reserve funds to pre-pandemic levels, as they will need to operate at very strong occupancy to generate sufficient surpluses beyond debt service coverage.

Rising expenses and inflation

As projects hope both occupancies and revenues will rebound to pre-pandemic levels, inflation and rising expenses could hamper overall operations and debt service coverage. Projects with weaker demand and financial profiles will have less operating flexibility and could face credit deterioration. Projects with significant demand and financial reserves will continue to differentiate themselves.

Student housing bond issuances

Throughout the pandemic, we observed that the most successful projects had structured operations with lower break-even occupancy, which provides additional flexibility when demand wanes; demonstrated strong connectivity with their associated institutions; maintained higher, and above-average, reserve levels; and had conservative debt service schedules that gave the projects more flexibility. New projects will likely require more support from associated institutions, higher mandatory reserve levels, and more conservative occupancy and debt service coverage projections to ensure success.