GCP Student Living — Continuing growth punctuated by COVID-19

DIGS provides investors with exposure to a well-located, modern and high-quality portfolio of private student accommodation assets, with a focus on assets in and around London and other similar markets that the investment manager expects to benefit from strong supply and demand imbalances beyond the current pandemic. The UK, and London in particular, has some of the highest-ranking universities in the world and is well placed to continue to attract both domestic and international students. In the period since IPO this has resulted in full occupancy, above inflation rental growth and capital growth. DIGS’s portfolio was again fully occupied with above-inflation rental growth (4.4%) for the 2019/20 academic year, until the onset of the COVID-19 pandemic in March 2020. Beyond the current pandemic challenges, the company’s existing assets, low leverage and strong cash reserves position it well for a resumption of growth.

DIGS responded to the pandemic lockdown and closure of HEIs by allowing direct-let students (79% of budgeted income) to forgo rent related to the final 2019/20 academic year rent instalment (20% of the annual total) if rooms were vacated (or a reduced rate if retained for storage). This resulted in direct let rents collected being 84% of the previously budgeted total. For the 2020/21 academic year, the majority of HEIs to which DIGS is exposed have plans for on-campus learning and are looking to welcome as many students as possible with a hybrid approach to teaching. With most beds (c 80%) configured as self-contained studios and all within 10 minutes’ walk of an HEI or major transport link, the portfolio is well-suited to the current situation. Student applications, especially international students, have continued to grow, but lockdown and travel restrictions have affected room bookings. At the time of reporting, 68% of rooms across the portfolio of student accommodation had been booked, compared with an average level of c 94% at the same date over the past five years. The investment manager expects the booking rate to increase, with a longer than normal booking cycle and positive impact in January as further postgraduate courses, with start states delayed by some higher education institutions, are scheduled to begin.

The shortfall in budgeted income for the 2019/20 academic year, which runs from mid-September, will also have a negative impact on Q121. Despite a positive first-time impact from the completion of Scape Brighton, the current level of bookings for the 2020/21 academic year will also weigh on the current FY21 financial year. Our forecasts assume that 75% of the 2020/21 direct let rent roll potential is earned as income, but we also provide a sensitivity analysis to alternative outcomes. Our base case also assumes a recovery of end-FY20 rent arrears in respect of nominations agreements and long-term leases without concessions or impairment. For the 2021/22 academic year we assume a 3% increase in rents with rent roll fully earned. This benefits FY22 strongly but will not be fully felt until FY23. We assume no overall change in like-for-like portfolio valuations, although the completion of Scape Brighton should have a positive impact. Nor do we assume any positive impact from acquisitions despite loan to value of c 22% at end-FY20 being well below the 30% medium-term target.

GCP Student Living (DIGS) is a UK real estate investment trust (REIT), externally managed by Gravis (see below), that invests in UK student residential property. The company is differentiated from listed peers by a focus on investment in properties that are located primarily in or around London. The investment manager believes that London and a small number of similar markets, will continue to benefit from structural supply and demand imbalances for student residential accommodation and will remain attractive to international students as a place of study.

The company has a premium listing on the official list of the FCA and its shares trade on the Premium segment of the London Stock Exchange (LSE) and are a constituent of the FTSE 250 Index. The company’s investment objective is to provide shareholders with attractive total returns in the longer term through the potential for modest capital appreciation and regular sustainable dividends with RPI-inflation linked characteristics. Although a small minority of DIGS’s rental income is contractually inflation linked, until the impact of COVID-19 like-for-like rental growth had increased in real inflation-adjusted terms for several years (with an average annualised uplift of 3.9% since IPO).

At the time of the IPO the company set a target annual shareholder total return (change in share price with dividends reinvested) of 8–10% and it had comfortably exceeded this in the period leading up to COVID-19. As a result of the pandemic, the total shareholder return in FY20 was a negative 20.6%, having been a positive 24.3% in the first half of the year, taking the annualised total shareholder return since IPO to 7.4%. This is still more than double the return on both the FTSE All-Share Index and the FTSE EPRA NARIET Index over the same period, even if slightly below the target set at IPO. NAV total return (the change in net assets plus dividends paid) continued to be positive in FY20 at 7.6% and the annual average compound return since IPO is 10.6% (or 12.9% assuming dividends are reinvested at the date declared as per company data).

DIGS has a fully independent board that is responsible for the effective stewardship of the company’s affairs, including corporate strategy, corporate governance, risk assessment and overall investment policy. The chairman since IPO, Robert Peto has announced that he will retire from the board at the next AGM, to be held in late 2020. His replacement as chairman will be David Hunter who joined the board in May 2019. The other three independent non-executive directors and their dates of appointment are Malcolm Naish (2013 IPO), Marlene Wood (March 2015), and Gillian Day (February 2018). Collectively the board brings a depth of experience in finance and investment markets, real estate and corporate stewardship. Full biographies may be found at www.graviscapital.com/funds/gcp-student/company-info#the-team. The board of DIGS has appointed Gravis to provide day-to-day investment management services, and Scape Student Living as the primary property manager.

Gravis is alternative investment manager, established in 2008, and privately owned by its directors and founding members. It manages c £3.2bn in assets including two other listed, closed-end vehicles: GCP Infra (market cap c £1bn), invested in long-term UK infrastructure projects; and GCP Asset Backed Income Fund (market cap c £400m), investing in asset-backed lending.

Nick Barker has day-to-day responsibility for the provision of investment advice to DIGS. Nick Barker is a chartered surveyor who joined Gravis in 2015 after eight years with Schroder Real Estate Management, where he was head of alternatives for the real estate business and a member of the fund management team.

Scape Student Living, a global developer, manager, and operator of purpose-built student accommodation (PBSA), provides property management services to DIGS in respect of all of the operational assets other than Water Lane Apartments in Bristol.

Revised investment and property management arrangements were recently announced, taking effect from the beginning of FY21. Since IPO, the investment management fee paid to Gravis has been set at 1.0% of net assets and from this entitlement, Scape has received c 0.25% of NAV pa. While Scape manages the facilities for which it is responsible, the actual asset management costs (such as on-site staff, utilities, etc) are paid directly by DIGS, a structure that is both operationally and tax-efficient, avoiding additional non-deductible VAT expenses that may otherwise arise.

Under the new arrangements DIGS will pay a reduced investment management fee to Gravis but will become directly responsible for payment of property management fees to Scape. The board believes that the revised management arrangements will provide DIGS with a competitive investment management fee basis and more closely align property management fees to relevant operational metrics in a manner that is more akin to the market standard seen in the UK sector.

The modified investment management fee introduces a sliding scale that allows shareholders to benefit more fully from the growth in net assets:

The revised property management fee, to be paid directly by DIGS quarterly in arrears, comprises:

The property management fees related to PBSA are subject to a minimum level based on 80% of the relevant budgeted annual property management fees where group occupancy is materially adversely affected by a pandemic or epidemic, including COVID-19. Certain costs that are currently incurred by DIGS, amounting to c £0.8m in FY20, will be assumed by Scape.

DIGS says that by way of illustration, had the revised arrangements been in place during FY20 it would have benefited from approximately £0.6m of cost savings compared with those reported.

As at 30 June 2020 (end-FY20), the portfolio comprised the 10 modern, high-quality operational assets and one development asset (Scape Brighton), providing a total of 4,116 beds, fully occupied by students from 82 different HEIs at the start of the 2019/20 academic year. In aggregate, the number of assets was unchanged on FY19, although the student accommodation at Circus Street, Brighton, was completed on time and became operational under a 21-year lease with annual uplifts, to a subsidiary of Kaplan Inc, a global education provider. In the current financial year, Scape Brighton is expected to be fully operational during September and October 2020, having been affected by minor construction delays as a result of the pandemic.

The aggregate portfolio valuation at end-FY20 of just more than £1bn reflected an average net initial yield of 4.44% (FY19: 4.54%). During FY20 the portfolio experienced a 3.2% like-for-like valuation uplift (ie excluding ongoing development investment) driven primarily by modest yield contraction, with valuation gains focused on the London assets, Scape Mile End, Scape Wembley and Scape Bloomsbury.

The primary focus of the portfolio is on assets in and around London (80% by value) but more generally the investment manager seeks markets with good levels of demand and high supply-side barriers. At a more local level, the assets are located close to HEIs and/or major transport hubs. This convenient local position combined with the configuration of the accommodation (c 80% of rooms being self-contained studios) should be more than usually advantageous while COVID-19 remains a concern.

Strong but selective portfolio growth since IPO has included properties acquired under an investment pipeline agreement in place with Scape Student Living, providing the company with the opportunity to acquire high-quality, purpose-built assets in good locations, while avoiding development risk and mitigating cash drag. Due to recent market uncertainty resulting from the COVID-19 pandemic, DIGS recently allowed its forward-purchase agreement in respect of Scape Canalside to lapse. The pipeline agreement with Scape has also now lapsed.

A conditional forward purchase agreement remains in place, providing the company with an opportunity to acquire a high-specification, purpose-built asset (Guildford II) in the same location as its existing Scape Guildford asset. The property has completed for the 2020/21 academic year, providing 403 beds. If acquired the property would form part of an enlarged Scape Guildford asset, providing a combined 544 beds in the same locality as the University of Surrey with potential to benefit from economies of scale. DIGS is not required to proceed with this acquisition and any decision is likely to take account of market conditions. However, with end FY20 gearing of c 22% running well below the medium-term target of 30% and our assumption that market conditions are likely to revert to normal for the 21/22 academic year, we have included the acquisition of Guildford II in our forecasts. Using the valuation of Scape Guildford as a benchmark, we assume an acquisition in early FY22, for £81m (before costs of acquisition) at a net initial yield of 5.15%, generating c £4.3m of annual gross profit.

The number of students applying for university places continues to significantly exceed the number of places that are available by around one-third, and the pandemic has had no negative impact on the number of student applications for the 2020/21 academic year. Data from UCAS show that at the 30 June 2020 application deadline, total applications of more than 650k were up 2.3%. International (non-EU) student applications showed the strongest increase (9.6%) and UK applications also increased (1.6%), reflecting a further increase in the participation rate. EU applications were 2% lower but have previously benefited from government measures aimed at mitigating any impact from Brexit.

Amid the pandemic, what remains unclear is the number of student applicants who will actually take up their offers. Early September data from UCAS showed that undergraduates intending to start their chosen university courses were up 3.5% to more than 500k, with international students up 7.0% and UK students up 3.8%. EU students were showing a decline of 5.4%.

The continuing trends of more student applications and increasing numbers of international students are positive for DIGS, as too is the migration towards better performing universities.

Since the UK government raised tuition fees to a maximum of £9,000 pa in 2012 (and subsequently increased to £9,250), which was followed by a removal of the cap on undergraduate student numbers in 2015, there is clear evidence that many students are influenced in their choice of university by its cost and the expected future benefit. This has enabled the top universities to grow in size while maintaining their academic requirements. Given its concentration of top universities (home to six of the top 40), London has benefited.

The demand for full-time higher education and the supply of purpose-built accommodation is not evenly distributed across the UK, and London, home to 23 universities, has one of the largest student populations of any city in the world. From a student demand-supply perspective, the differentiating features of the London market, where 83% of DIGS’s assets are located, can be summarised as:

Brighton shares similar market dynamics to London. It is home to the University of Sussex (a UK top 20 university) and the University of Brighton, with an aggregate c 32,000 students including c 8,000 international students. The city is also home to two of the largest English language foundation course providers in the UK.

The investment attraction of PBSA in the core markets in which DIGS is invested has been reflected in yield compression since IPO. Overall UK student accommodation investment volumes of £5.2bn in 2019 were the highest since 2015 and Gravis estimates that a further £5.1bn has been traded or put under offer in the first half of 2020. Current year activity is dominated by the £4.7bn acquisition by Blackstone of the 28,000 bed (6,800 in London) IQ Student portfolio at a yield (estimated by Gravis) of 4.2%. Notably, the transaction completed in May, during the pandemic. Such investment activity, combined with the expectations of above-average rental growth over the long term, continues to support valuation yields

Until the COVID-19 pandemic came along, FY20 was shaping up to be another year of strong income growth, based on an increase in operational assets, fully occupied with above-inflation rent increases, and capital appreciation. At the half-year stage, rental income had been c 18% ahead year-on-year and adjusted earnings by more than 20%. Viewed against the unprecedented challenge of the pandemic, the full year outcome may justifiably be described as robust, although the pandemic effects will continue to be felt through the current year, as we discuss in the following section.

To target selective asset growth, DIGS seeks a balance of equity and debt capital with a medium-term target for gearing of c 30% (end-FY20: 21.9%).

In late December 2019 DIGS raised gross proceeds of c £77m in a non-pre-emptive share placing, under existing shareholder authorities. The issue was launched in response to specific demand from APG Asset Management in its capacity as the discretionary manager of various pension funds, which had indicated its intention to subscribe for up to £75m of shares, subject to a minimum of £50m. The placing price of 186p was at a premium of 10.4% to the end-Q119 NAV per share and a discount of 6.3% to the share price immediately ahead of the launch. The placing was substantially oversubscribed requiring applications to be scaled back, with APG acquiring shares to a value of c £50m. The equity proceeds were raised in the context of the investment plans in place at the time, subsequently curtailed or at least deferred by the COVID-19 pandemic. This has left DIGS with a strong liquidity position and modest debt.

Available debt facilities at end-FY20 were £335m of which c £282m had been drawn. The facilities comprise £235m of long-term fixed-rate borrowing (at an average 2.96%) and £100m of shorter-term, more flexible floating rate debt. The latter comprises a £45m re-drawable debt facility of which c £15m was drawn at end-FY19 and a £55m development loan facility, £32m drawn. Once Scape Brighton is completed and stabilised, it will be possible to refinance the development loan, which is due in December 2021 with a conditional option to extend for a further 12 months. Undrawn debt facilities and cash resources (c £60m at end-FY19) provide ample near-term liquidity.

The average cost of the drawn debt at 30 June 2020 was 2.95% with a weighted average maturity of approximately five years. Allowing for c £60m of cash at end-FY20, the net debt was c £222m and the net loan to value ratio was 21.9%, well below the medium-term target of 30%.

DIGS’s immediate investment plans include completion of Scape Brighton and a small amount of remaining investment on the office at Circus Street, Brighton. We estimate that these amount to c £25m. As discussed below, we have also assumed the acquisition of the ‘Guildford II’ forward purchase asset in H121, which we assume to be funded by the remaining undrawn debt facilities and additional debt of c £27m (as yet to be arranged) at assumed c 3% pa. This takes our forecast LTV to c 30%, in line with the medium-term target.

Academic year versus accounting year

As noted above, FY20 rental income of £47.8m represented 92% of the budgeted total for the year. As the company’s academic year runs for 51 weeks from mid-September, the student rental income reported for the year to 30 June 2020 (FY20) comprises c 25% of the 2018/19 academic year income and c 75% of the expected 2019/20 academic year income. The negative impact of the pandemic on 2019/20 academic year income has affected FY20 financial year income relative to budget and will also have a negative impact on Q121 compared with what would otherwise have been expected.

Total budgeted income for the 2019/20 academic year was c £50.5m, comprising 79% from direct lets to students and 21% from nominations agreements and long-term leases (including a small amount of commercial space incorporated within the student accommodation assets). Rental payments for direct lets are made in three tranches for each academic year, with c 40% received in September, c 40% in January and the remaining c 20% in April, although in accounting terms the expected income is spread evenly across the year. For the 2019/20 academic year, 84% of budgeted direct let income was collected, with the shortfall emerging with the pandemic during the second half of the year. The company has also indicated that in cash terms, some of the budgeted rental payments in respect of the nominations agreements and long-term leases were in arrears, but that the income had been accrued as recovery was anticipated. In cash terms, 82% of all budgeted income (direct let, nominations agreements and long-term leases) was collected, representing a cash income shortfall of c £9m for the academic year. Due to the nominations/long-term lease accruals, the group accounting income shortfall is smaller and relates primarily to lower than budgeted direct let income. Some of the 2019/20 academic year income shortfall has been reported in FY20 but it will also have an impact on the first quarter of FY21.

At the time of reporting, 68% of rooms across the portfolio of student accommodation, including Scape Brighton for the first time, had been booked. This compared with an average level of c 94% at the same date over the past five years. The pace of bookings contrasts with the growth in student applications and acceptances. The investment manager anticipates that students have delayed booking accommodation for the 2020/21 academic year due to COVID-19 uncertainty and expects bookings to increase from the current levels later in the enrolment cycle than is normally the case.

DIGS has a long-term nominations agreement with a subsidiary of INTO University Partnerships, a provider of foundations courses, for 210 beds at Scape East. INTO accounted for c 5.9% of the 2019/20 academic year budgeted income (c £3m) and rents are in due in advance of three academic year terms. At the time of reporting, INTO was in arrears in respect of their latest rental instalment and DIGS is in discussions with INTO regarding the outstanding balance. Anticipating full collection, DIGS accrued the contractual income in FY20, with 83% having been received.

Rental income in respect of the lease at Circus Street, Brighton, continued to be received in line with expectations. The 450-bed student accommodation building is contracted on a 21-year lease to a subsidiary of Kaplan Inc, a global education provider.

A nominations agreement for 100 of the beds at Scape Greenwich has been treated in a similar manner to the direct lets and released from the final instalment of the 2019/20 academic year on a case by case basis.

Scape Shoreditch includes 49,000 sq ft of commercial space that is let on a long-term occupational lease to a subsidiary of WeWork and part-guaranteed by its US parent company. Rents are payable quarterly in advance and account for c 4.9% of the 2019/20 academic year annual budgeted income (c £2.5m). WeWork paid approximately half of the quarterly rent billed in advance in both March and June and discussions are underway regarding the outstanding payments. In anticipation of recovery, the outstanding rent was accrued in FY20, with c 90% having been received.

Scape Mile End includes 22,000 sq ft of teaching space let to Queen Mary University of London where rents continue to be received as expected.

The key forecasting uncertainties for the current financial year (FY21) are with regard to the eventual outcome of direct let student accommodation bookings and whether payment patterns in respect of the nominations agreements and long-term leases return to normal without loss of future rental income or impairment of accrued receivables. Regarding the latter, given the covenant quality of the tenants and the encouraging fact that rents continued to be accrued in FY20, we will focus on the group income sensitivity to direct lets.

A two-week deposit is payable when direct bookings are made. This provides stickiness to bookings but is no guarantee that rents will be paid for the duration of the year. Final payment waivers in respect of 2019/20 were made at the discretion of the company, but had the pandemic struck earlier in the academic year rental receipts could have been lower. However, assuming no repeat of the conditions that applied in 2019/20, primarily the closure of HEIs, we use bookings as a guide to academic year rental income and Exhibit 9 shows a range of possible outcomes for FY21 group gross rental income and EPRA earnings. For simplicity we have assumed that nominations agreement and long-term lease (IFRS) income is unchanged on FY20 (ie no contractual rent uplifts, no negative impact from rent concessions/impairments, and no benefit from completion and letting of 29,000 sq ft of office space at Circus Street). Direct let rent roll (assuming full occupancy) is estimated to increase from the c £40m budgeted for (but not fully earned) in 2019/20 to c £46m for 2020/21 including Scape Brighton (we estimate a potential rent roll of £6.2m). We have not assumed a positive impact on direct let rent roll from rent uplifts and any discounting is effectively captured in the assumed percentage of rent roll earned.

For the 2021/22 academic year we have assumed a return to normal market conditions with rental income reflecting the full rent roll potential. Given the company’s medium term 30% LTV target we also assume it proceeds with the acquisition of the ‘Guildford II’ forward-purchase asset. We estimate an increase in the direct-let student accommodation rent roll to £52.5m for the 2021/22 academic year including c £5.0m from Guildford II and 3% rent increases. For the group, we also assume a 2% increase in the nominations/long-term lease rent roll.

Incorporating the above analysis, our central case forecast for FY21, perhaps better described as a scenario at this stage, is based on 75% of 2020/21 academic year direct rent roll being earned. Our assumptions of a return to normality for the 2021/22 academic year and the acquisition of Guildford II have a positive impact on the final three quarters of FY22 although Q122 will continue to reflect the 2020/21 academic year outcome. Our forecasts are shown in detail in Exhibit 13. We assume no net change in property valuation, which in reality is likely to include a positive impact from the completion and opening of Scape Brighton and the off-market acquisition of Guildford II (less acquisition costs) but may also be negatively affected by the continued near-term pressure on occupancy and income across the sector.

The unchanged FY20 DPS was 86% covered by adjusted earnings and the company continues to target fully covered dividends over the longer term. No near-term dividend guidance has been provided and we have assumed a continuation of quarterly DPS at the same rate as Q420 with the 1.42p per quarter annualising at 5.68p. Our forecasts indicate a significant dip in DPS cover in FY21 (48%), based on adjusted earnings including licence fee income on the forward-funded developments, but substantially full cover in FY22 (with no difference between EPRA and Adjusted Earnings following completion of the existing developments in FY21). If DIGS opts to reduce DPS payments in FT21 and increase cover, this would enhance NAV per share such that there would be no impact on NAV total return.

At the time of the IPO the company set a target shareholder total return (change in share price with dividends reinvested) of 8–10% and had comfortably exceeded this in period leading up to COVID-19. As a result of the pandemic, the total shareholder return in FY20 was a negative 20.6%, having been a positive 24.3% in the first half of the year, taking the annualised total shareholder return since IPO to 7.4%. This is still more than double the return on both the FTSE All-Share Index and FTSE EPRA NARIET Index over the same period, even if slightly below the target set at IPO. NAV total return (the change in net assets plus dividends paid) continued to be positive in FY20 at 7.6% and the annual average compound return since IPO is 10.6% (or 12.9% assuming dividends are reinvested at the date declared as per company data).

Based on the 6.15p aggregate DPS paid for the year to 20 June 2020 (FY20) the trailing yield is 5.0%. Annualising the Q420 DPS of 1.42p (5.68p), the yield is 4.7%.

The current more than 20% discount to EPRA NAV per share compares with an average c 2% premium since IPO (and a peak of c 12%) and seems to reflect the current uncertainty more than the positive underlying fundamentals that we expect to remain in place as the pandemic comes under control.

In Exhibit 12 we show a summary valuation and share price performance comparison for the three UK-listed student accommodation companies: DIGS, Unite and Empiric Student Property. The DIGS P/NAV, based on the most recently reported EPRA NAV per share in each case, is a little below average, above Empiric and below Unite. A comparison of yields is currently challenging. While DIGS has continued to pay quarterly DPS amounting to 6.15p in the year to 30 June 2020, DPS payments have been disrupted at Unite and Empiric, both of which have slightly higher gearing than DIGS (Unite c 33% and Empiric c 35% at 30 June 2020), as a result of the pandemic. Having paid DPS of 1.25p per quarter in respect of the year to 31 December 2019 (including 1.25p declared 17 February 2020 in respect of Q419), Empiric has taken the decision to suspend dividend declarations pending an update in Q420. Unite cancelled payment of its final dividend in respect of the year to 31 December 2019 and while it says it anticipates reinstating dividend payments in 2020, including the potential to announce an interim dividend later this year, the timing of the reinstatement is still to be confirmed.