Updated: Sep 10, 2020
By: Johan Rosenberg, Chairman
60 Minutes: Colleges and universities prepare for fall classes - https://www.cbsnews.com/news/colleges-reopen-fall-students-coronavirus-pandemic-60-minutes-2020-06-14/
HyFlex Instruction Model - https://library.educause.edu/-/media/files/library/2010/11/eli7066-pdf.pdf
67% of U.S. Colleges and Universities are planning for an in-person fall semester https://www.chronicle.com/article/Here-s-a-List-of-Colleges-/248626
San Diego State University reaches financial close on $23.5m upper-division/graduate student P3 housing project - https://www.studenthousingbusiness.com/capstone-development-closes-on-financing-for-23-5-million-student-housing-project-at-san-diego-state-university/
University of Missouri-Kansas City takes the first steps towards tearing down a troubled P3 housing project https://www.kansascity.com/news/local/article243549582.html
Debt Service Coverage and Implications for Low Density Single Person Occupancy. Administrators across the country are developing plans for the safe reopening of on-campus housing. In this article, we highlight some of the financial implications for lower occupancy using a simplified example. The example demonstrates that under lower occupancy scenarios, the University and/or their P3 partners will need to rely on University support or, if University support is not feasible, draw on reserve funds to make debt service payments. The example considers a basic, generalized scenario to understand what happens to the project’s financial performance under lower than expected occupancy and is focused on addressing two basic questions:
What would be break-even occupancy for a typical P3 undergraduate housing deal?
What happens to the debt service coverage ratio and cashflow if a University decides to only have single person occupancy in each unit?
In answering these questions, we also discuss potential long-term implications for each scenario.
Scenario – Normal Operations
Consider a University P3 housing project has 1,000 beds configured with occupancy as follows: 100 quad units (400 beds), 200 double units (400 beds) and 200 single units (200 beds); in total, the 1,000 beds are spread across 500 housing units. If we assume an average cost per bed of $10,000, the project has $10 million of revenue potential. Using an assumption of 95% occupancy (5% vacancy), other losses of 1%, and operating expenses of 42% of potential revenue, the project would have net operating income of $5.2 million. If debt service payments are 40% of potential revenue, then debt service payments are $4.0 million, leaving net cashflow of $1,200,000.
Based on the above parameters, the debt service coverage ratio (DSCR), which is equal to net operating income / debt service payments, would be 1.3x ($5.2 million / $4.0 million).
Scenario – Break-Even Occupancy
Break-even occupancy occurs when there is a 1x DSCR. If we assume that losses and operating expenses remain constant, we can solve for the level of vacancy that leads to a 1.0x DSCR. In the simplified example, this level of vacancy is 17%, which implies an 83% occupancy, or 830 students living in the project. If break-even occupancy was a University goal, the University has several options to achieve break-even occupancy at the lowest possible density. The specific arrangements would depend on the specific layout of the rooms and the associated common space but, for this example, there is not a scenario where all students can occupy individual living spaces with break-even occupancy. We are able to get close, but only if the quad units are considered to have individual living spaces and single students are placed in each double room. This would allow for 800 students, but requires 400 students to share the common living room spaces in their quads.
Long-term Implications: Although break-even occupancy occurs at 83% occupancy, the 1.0x DSCR still breaches the 1.3x DSCR covenant, resulting in a technical default. Depending on your deal structure, this deficiency will need to be cured through University support and/or improved performance in future years. This may also trigger requirements for the P3 partner to engage an outside consultant to help develop strategies to improve occupancy.
Scenario – COVID-19 / Single Occupancy
If, in response to COVID-19, the University decides that the risk of an on-campus outbreak is best minimized through single occupancy of housing units, this has significant implications for the financial performance of the project. The example project has 500 units; a single student in each unit implies 50% occupancy and a reduction of net operating income to $700,000. Net operating income of $700,000 is substantially below the required debt service payment of $4 million. If University financial support were not feasible due to other budgetary limitations, reserve funds - the debt service reserve fund, in our example - could be drawn upon to make the $4.0 million debt service payment.
Long-term Implications:Most P3 housing deals are structured such that reserve funds, such as the debt service reserve funds, have to be replenished to specified levels before any form of distributions can be made. The result of this requirement is that even if housing operations return to “normal” in subsequent years, the University would not receive “normal” distributions for several years, as reserve funds are replenished. In the example, normal distributions would not return for least 3 years ($3.3 million / $1.2 million = 2.75 years) while revenue is diverted into the debt service reserve fund. It is almost unimaginable, the lasting scars the COVID-19 pandemic will leave on university housing operations.
Johan Rosenberg and Justin D. Krieg, PhD
DeveloP3rs - a Division of Blue Rose Capital Advisors, LLC/ TRIL 1 LP
www.DeveloP3rs.com | (952) 746-6050 | firstname.lastname@example.org