Harrison Street has built a very successful business by investing in alternative real estate asset classes. With more than $56 billion in assets under management, the firm has been a leading investor in the student housing sector for two decades. Leading the firm is co-founder and CEO Christopher Merrill. SHB recently spoke with Merrill to get his take on commercial real estate, and the student housing sector.
SHB: What are your thoughts on the recent (late July) interest rate hike? How do you think it will affect the student housing sector?
Merrill: It is overall good news that we are experiencing a soft landing for the economy. The challenge is that we are not getting a consistent signal. It can be difficult for an investor to allocate capital in this type of economic climate when rates are uncertain. The positive is that the lack of freely available capital has created the best fundamentals the industry has seen over the past two decades from a supply and demand perspective. The challenge of raising equity, the cost of financing and the limited number of lenders has really choked off new supply. If you are already active in the student housing sector and have good relationships, it is a terrific time to be in the business.
SHB: How do you assess the state of the student housing sector right now?
Merrill: For Harrison Street, the pipeline is terrific. We have a lot of properties under construction. We work with 15 to 20 development partners. Over the past few years, we have added a few new relationships with strong developers who had aligned themselves with other capital sources that were not as committed to alternative real estate. We have always been a pure play alternative real estate investor and have invested in student housing since 2005. Even through the Global Financial Crisis (GFC) we continued to invest because alternative sectors weren’t saddled with triaging problems like traditional real estate. We are seeing a similar situation today with some of the traditional sectors, such as office. As a result, they are hitting the pause button on new developments and investments, particularly outside their mainstay sectors. That has left a number of student housing developers at the altar. That, in turn, is creating some opportunities for us to step in and fill that role. The student housing fundamentals today are some of the best that we have seen in our nearly 20-year history.
SHB: As you mentioned, occupancy and rental rates are among the fundamentals that are strong for the industry.
Merrill: That’s right. We are seeing record-level occupancy rates across our student portfolio, particularly for Power Five schools. This has also been accompanied by annual rental rate growth ranging from 5 percent to over 20 percent, although I think every owner has a few outlying projects that aren’t meeting the high industry averages. I always love at conferences when owners talk about how every one of their properties is 98 percent leased and has 5 percent to 7 percent rent growth, but the truth is that many owners are never going to have a 100 percent hit ratio. While we have some of these in our portfolio, we have continued to use our extensive amount of proprietary data from being a first mover in the space to continue to strengthen our investment funnel. This has led to Harrison Street picking better projects, in terms of what schools we want to own near, what the unit mix is, what the location should be. It’s easy for a project to go wrong if it’s in an unfavorable location or serving a school with declining demand. We have learned valuable lessons over the past two decades and been able to apply that knowledge to our investment strategy. To answer, though, we are seeing very strong occupancy and year-over-year rent growth portfolio-wide.
SHB: While you don’t have a crystal ball, do you foresee a change in the capital markets in the future?
Merrill: It is going to take time for the capital markets to loosen. From an equity standpoint, the larger fund managers are getting bigger. The student housing industry is still very fragmented. It is going to be hard for those larger groups with the dollar volume they have to deploy in individual investments. They are looking at larger portfolio acquisitions. Capital coming into the sector is likely to be challenged for a while and it will take time for equity to come back. At the same time, investors are just not sure what is happening with interest rates and so equity capital is also looking for distressed assets. They smell blood in the water from certain underperforming projects. In this industry, if an asset is not working it is usually because of the location, unit mix or weak submarket. Distress in the student housing sector is usually due to project fundamentals versus property operations. On the debt side, a number of lenders have pulled back from lending broadly to the sector. They are focusing on high-quality borrowers who have strong balance sheets and good track records. We have seen a clear signal that there will be debt capital for good operators and sponsors. Those owners who are new to the sector or who do not have a good balance sheet are going to find it hard to raise capital. It is very similar to the environment we saw as we were exiting the Global Financial Crisis.
SHB: There hasn’t been a lot of acquisition activity in 2023 compared to other years, yet Harrison Street continues to acquire. How is that possible?
Merrill: We have been in the industry a long time. We have created multiple investment vehicles that allow us to have a competitive cost of capital and we continue to invest through varying cycles. At Harrison Street, we don’t just have one strategy in student housing. We have buckets of capital to invest across the board from core to core-plus to value-add to opportunistic. We are a one-stop shop for our operating partners. Those multiple strategies have allowed us to be active throughout the real estate cycle over almost two decades. In 2023, we continue to have capital to allocate and given the capital market environment have been measured in our deployment. As an example, for one of our non-core strategies we reviewed nearly 1,000 opportunities over the past several months and ultimately moved forward with only 20 of those, about two percent, with the majority in development as we really like that positioning today. Supply has been choked off and our projects will be the newest to deliver in markets that continue to have resilient and growing demand.
SHB: Would it be accurate to say with market fundamentals as they are that you are leaning more towards new development today?
Merrill: We are bullish on development right now. A lot of the student housing developers who are successful today are ones that we backed during the GFC. It might be viewed as a contrarian play to the investor world — they want distressed assets — but if we can get exposure in a good market with a good location through new development, we are going to go for it. We have seen a lot of capital moving from traditional real estate investments to alternative real estate investments. Part of why we like development is that we are putting something in the ground now that will stabilize in two to three years, and that institutional capital is going to be looking to acquire these new assets in that timeframe.
SHB: You have made several investments in on-campus housing. Are you interested in further investment there?
Merrill: Yes, we are. We are one of the largest private investors in on-campus projects. We have built an interesting public-private partnership program for universities. Over the past decade, we have evolved how we work with universities on their on-campus housing. We have partnerships with more than 20 universities, and we are not just working with them on their housing, but with power plants, data centers, convention hotels and other non-academic facilities. If universities have a capital need where raising debt is difficult or not desired, it is a very compelling business for us to support their student housing or infrastructure goals. Not a lot of companies are active in the P3 business because it takes a lot of time to build and nurture these relationships, and a lot of handholding to get the projects done. These P3 structures offer our investors very attractive risk adjusted returns.
SHB: You have also had a lot of international expansion with student housing. What has enabled that?
Merrill: Our business is built around demographics; that is what drives Harrison Street. The demographics for student housing are global. We are probably the leading student housing investor outside the U.S. We are very active in student housing in Canada. We have assets in the United Kingdom, Ireland, Germany and Spain. It has been a lot of fun for us to evolve our student housing business from what it was 15 years ago. We are familiar with the European model and how business is done there. I lived in Europe in the late 1990s and invested across Europe in the late ‘90s and early 2000s, and I was one of the first investors to create a real estate investment fund for Central Europe in the late 1990s. Our team and European leadership have a lot of relationships across Europe. Once we realized we had a great expertise in the U.S., we knew we could bring that expertise overseas. Europe is 10 to 15 years behind the U.S. in student housing. We bring our capital and our experience to the market. We have a team of more than 40 people in Europe now. The fundamentals for the sector are even better there than in the U.S. because it is so far behind where we are in the U.S.
SHB: You have referenced your operator partners a few times. Can you talk about how you select who you are going to partner with? How do you approach your investments with them?
Merrill: We have worked with many partners over the past 20 years. There are some who we started in the business with that we still invest with today. We have always thought that the value we could bring to our investors was working with a diversified set of partners. Each of them has a different strategy as well as local expertise. We wanted to be diverse in our selection, so we could offer the best risk adjusted portfolio to our investor base. The operators we are choosing are focused on the sector and so they live and breathe it every day. They have strong balance sheets allowing them to invest alongside us as well as the ability to stand behind their projects. They have good track records and performance. We also look for character; we want to see that they have operated as well in bad times as in the good times. Over the years, we have had over 120 different partners across the different sectors where we invest. We want to see an edge; what makes them different? At the same time, we are a more hands-on investor, where we roll up our sleeves and act as a strategic partner. In some of our sectors, like healthcare and self-storage, we bring our partners together in conferences and help them by looking at best practices across the industry. Being a good partner pays off for both parties; we have some partners who have become close friends at different levels throughout the organization. It is almost like family. When times are tough, we can really show our character. We want to be there for them in good times and challenging times.
SHB: How does the student housing industry compare to some of the other sectors where Harrison Street is active, such as medical office, seniors housing or self-storage?
Merrill: The most comparable sector to student housing is seniors housing and healthcare. Before the pandemic, the concern was whether online learning would wipe out the student housing business. That was debunked by the pandemic. We then worried whether telemedicine would affect the medical office sector. When COVID hit, there was a scare among the seniors housing industry. But after each of these events, what we’ve learned is that each of these asset classes all have similar fundamentals around their resilience. In seniors housing, occupancies dropped during the pandemic because they could not admit new residents. You had natural attrition, so their occupancies dropped while waiting lists were building. We knew demand was not really changing, even though occupancy was temporarily lower. During the pandemic, we were active acquirers of seniors housing. Since then, we have seen nine consecutive quarters of positive absorption. The fundamentals of that business are great and continue to improve as the population ages, and supply is choked off in that sector as well. Medical office is also booming because there is a continued move by healthcare providers to the outpatient setting. That sector continues to be strong. Self-storage is an asset class that does well in good times and in bad. People choose storage units based on convenient locations, not price, and so it continues to do well. We are also active in the life sciences space, where there has been a lot of activity with new pharmaceutical developments. And finally, we are also active in data centers and clean energy. Our business is really about demographics; we don’t invest in asset classes where we try to time the economy or entrances and exits. It is about the long-term demographics for us.
SHB: What is your opinion on prop tech and AI?
Merrill: You could spend all day talking about all the prop tech ideas that get brought before us. We evaluate what we think we can utilize and drive better performance of the real estate. There are a few ideas in that area that we’ve found to be particularly interesting, like EV charging stations and a 3-D printing company that can print building structure on-site. We are working on another product that could be a tool for our student-residents. We look at prop tech seriously when it can drive a better bottom line. If it can’t do that, it won’t be a focus for us. AI, in particular, will be interesting for us from a data sampling and collection perspective. One of our challenges is that we have so much data; we’ve been in this business for a long time and have invested on, near or in partnership with over 300 universities in North America and Europe. How do we compile that data to tell stories and make better investment decisions? AI might be able to help us with that while reducing a labor burden.
SHB: Do you have any office building owners calling for your help in converting their properties to student housing or life sciences properties?
Merrill: We have done some conversions over the year, but mostly to medical office or life sciences space. If you have a B or C quality building that doesn’t have the right floor load or HVAC, it is tough to convert those properties to another use. It will be interesting to see how cities deal with these B and C office properties in the future. I think a lot of that will be resolved through public-private partnerships with local governments. Some of these areas where they want to convert office space to residential, the properties do not have the amenities needed to make a successful conversion.
SHB: You are obviously a busy man, but what do you do in your free time?
Merrill: I love to play golf and spend time with my family My wife has a local business that she is very dedicated to running. My daughter works with her, so it has become a bit of a family business. They’ve been occupied with their business, while I have been busy with Harrison Street and traveling quite a bit for work. So not a lot of free time, but when you do what you love it is very rewarding.
—Interview by Randall Shearin and Richard Kelley
This article was originally published in the July/August 2023 issue of Student Housing Business magazine.