Higher education projects have been a mainstay of the P3 market in the US over recent years. Whether it’s schemes to deliver new accommodation, or to improve the energy systems of a campus, there has been a steady stream of projects coming to market for investors and contractors to get involved with.
However, the sector is facing a number of headwinds at present that could have a significant impact on that pipeline, and change the approach of institutions that have so far been keen to develop their campuses as part of a wider program to attract the top students and staff.
At the top of the list of obstacles is the current battle with rising inflation. An issue affecting every area of American society - as well as countries around the world - rising levels of inflation are causing serious problems for those looking to build new projects.
Recent figures have suggested material prices are rising by double-digit percentage points and are showing few signs of slowing down. Meanwhile, labor costs are also rising as demand for construction projects has grown substantially since countries around the world decided to look to infrastructure to help build their economies out of the downturn caused by the Covid-19 pandemic. Add to that the war in Ukraine, which is constraining access to raw materials, and project costs are threatening to make many deals unaffordable.
“We have seen several [higher education P3 transactions] on hold because the guaranteed maximum price contracts are X-plus a great deal more due to inflation and the volatility of steel, concrete and wood products, and the disruption in the supply chain,” says Fred Marienthal, partner at law firm Kutak Rock.
Another expert says he is working on a student accommodation project that is currently facing capital expenditure increases while the cost of debt is also going up. “That is putting real strain on the project,” he says.
“Inflation is part of a larger issue facing all capital projects,” says James Birkey, vice president of public institutions at JLL. “Capital costs in projects have been extraordinarily high and have been rising quickly. Until recently, that has been hidden by historically low interest rates. So the interest rate rises are going to challenge what institutions are going to be able to do.”
His colleague, Lindsay Stowell, says that these financial pressures are resulting in universities questioning whether they should proceed with projects or wait for costs to come down. Most experts argue that waiting offers little advantage, because in reality the costs rarely start to come down, with the more likely scenario being that they will level off. That may make forecasting a bit easier, but wouldn’t have much impact on making a project cheaper.
Part of the problem here is that, in many cases, institutions are looking to build new accommodation that is provided at below market rent for their students. As costs rise, the gap increases between what they want to charge students and how much those rents will cover the build price. “With increasing inflation driving costs up, it may be appropriate to consider higher revenues assumptions,” suggests Thomas Mulvihill, managing director and group head of infrastructure finance & P3s at investor KeyBanc Capital Markets. “That can only go so far, but it may provide a little bit of relief.”
“Universities must understand the financial impact of projects on the resulting student room rates,” Stowell explains. “In deciding to build at these high construction costs, they face the question of whether they can charge students more or else find a funding source to subsidize the student rents.”
Part of the solution may be greater use of alternative delivery models, such as P3. “The demand for infrastructure doesn’t go away as the financial situation changes,” says Geoffrey Stricker, senior managing director at Edgemoor Infrastructure & Real Estate. “The need for creative thinking is even more relevant than when people are flush with money. We are having lots of conversations with clients on how to use P3s to help them in the current economic situation.”
He also highlights the federal government’s commitment to infrastructure investment as a way out of the economic difficulties caused by the pandemic. With large sums of money flowing from the White House via Capitol Hill, Stricker believes that those looking to deliver new projects may be better off doing so sooner rather than later, while the money is still available.
However, this focus on government dollars could turn some institutions away from a P3 approach, in the belief that straightforward government borrowing can help to lower the cost of capital. “They are maintaining some elements of a P3, such as design, build, and maintain, but they are taking the finance out,” says Marienthal.
“Some projects are so mission critical that institutions and their partners are doing an immense amount of value engineering or phasing of their projects so that they can keep the momentum going,” he continues.
Another option being considered by some institutions is to buy assets instead of building new ones. “In some cases, universities are looking at the option of acquisition as an alternative to construction for student housing given the cost dynamics that exist today,” says Stowell. However, this will often require properties in appropriate locations to be available, a luxury that many campuses simply won’t have.
Despite the financial pressures, the need for new university infrastructure looks set to grow. Over the past two years, during the uncertainty caused by the Covid-19 pandemic, questions were raised over the need for certain campus facilities. Would students return in large numbers, for example? And if they did, what would they (and health and safety standards) require from their universities to keep them safe?
As life has begun to return to normal, this year’s September intake is expected to be reaching record numbers, as students show little sign of wanting to stay at home or simply skip their university years.
“Institutions know the value of having students on campus, and students have shown they want to be there,” says Marienthal.
“We are not hearing about lingering occupancy struggles with student housing,” says Mulvihill. “It appears students have returned and some universities have seen 20%-plus increases in applications.”
“The pandemic seems to have exacerbated a great divide in the higher education landscape,” adds Stowell. “While many large top-tier universities are seeing a robust recovery with record enrollments, there is a large swath of colleges and universities struggling with declining enrollment and inadequate financial resources.”
This means that the demand for high quality facilities - from accommodation through to research, sports and teaching facilities - is as high as ever as institutions look to attract and retain students and staff.
One potential fly in the ointment, however, is the so-called enrollment cliff facing the US student sector in the coming years.
Projected to begin as soon as 2025, and expected to continue for decades, there is anticipated to be a significant decline in the number of school leavers heading into university. This is because the US birthrate dropped significantly during the Global Financial Crisis starting in 2007, and has yet to pick back up. With fewer children, there will be fewer school leavers and therefore fewer university applications.
“Some institutions are reticent to build new facilities when they don’t know what the demographics coming through will look like,” says Marienthal. “Some may be looking to get by with what they have as student numbers fall.”
However, he and others are hopeful that this could in fact have a stimulant impact on the P3 market. “Institutions will be thinking about how much new debt they can take on,” Marienthal continues. “That may make P3 more attractive.”
Stricker agrees. “Universities are recognising that to be competitive, one of the ways they can differentiate themselves is through their facilities. So we are still seeing great demand for universities to position themselves to attract the best and brightest students, faculty, and staff.”
He is optimistic that accommodation projects will still be at the forefront of many universities’ thinking beyond 2025. “A lot of student accommodation was built 20-40 years ago and as a result they don’t meet the needs of today’s students. So I don't see student accommodation deals slowing down anytime soon.”
More than housing
Stricker adds that innovation campuses remain popular with universities as a way to diversify their income and attract new faculty, staff and students. The enrollment cliff could exacerbate that: with money from new students potentially falling, expanding research capabilities could be seen as a way of driving revenue.
Away from accommodation, it is clear that the pandemic has left a mark on the way institutions think about their estate.
Some experts are seeing a change in the approach to teaching facilities. “It may be that universities are no longer seating people elbow-to-elbow in lecture halls, which may mean smaller spaces end up being changed because of the lack of space,” says Mulvihill.
Some institutions may choose to use existing larger spaces, but have classes that are hybrid, so that students in the lecture halls can be more spaced out while others watch online.
“Universities are seeing more non-traditional students, for example those that are not 18-22 years old and those with full-time jobs, completing their studies online,” Mulvihill continues. “That provides more income for universities and from our experience traditional undergraduates are taking most of their courses in person, rather than online.”
Marienthal also suggests there will be more scrutiny on universities that do decide to build large new facilities. “State funding for higher education will be different as states ask why they need these big buildings, and they won’t be willing to be partners in paying for them,” he suggests.
Administrative spaces are also being reconsidered by universities. “We have clients that are looking at their administrative space differently,” says Birkey. “For example, do they need to have their fundraising office or their financial administrative services on-site, nine-to-five, every day?”
“Many universities are looking at how they can rationalize or repurpose their administrative real estate for other uses that can better meet their space needs in a post-pandemic reality,” agrees Stowell.
“There is a lot of big picture work for campuses, as institutions consider what the future looks like in a post-pandemic world,” concludes Birkey.
The pandemic has certainly added a new dimension to the university P3 market. However, rather than threaten an end to the sector, as once may have been feared, it has simply provided a junction from which new routes for universities to explore are emerging. The pandemic hasn’t stopped the ambition of university projects - and all the signs suggest a fall in student enrollment won’t either.
Higher Education In Numbers
In the 18 months from the start of January 2021 to the end of June 2022, there were 31 projects captured in the Projects Bulletin data, of which five were financial closures. That leaves 26 projects at various stages of procurement, although 11 of those were at shortlist stage or further, meaning there were 15 projects in the market for investors, or considering going out to tender.
Of the projects in procurement, seven are for housing developments, while three are mixed-use/campus schemes. The remainder are a mixture of initiatives, such as energy or specific research or commercial facilities.
This spread compares favorably with the figures compiled in our 2021 Report, which also saw student accommodation dominate the sector.
While more commercially focused projects such as innovation districts will continue to have a place, it appears that the drive to improve student facilities so that institutions remain an attractive place for students continues to be at the heart of universities’ thinking.