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Income Strips and Student Accommodation - an alternative funding model for Higher Education Institutions

  • United Kingdom
  • Real estate investment


Economic and political uncertainty since the Brexit vote and fear of a predicted debt crisis have increased funding pressures on Higher Education Institutions when putting their estates strategies into action.  A perfect storm of a predicted drop in EU student numbers, loss of EU research funding, potentially decreasing property values and increasing construction costs means that the funding of capital projects is likely to remain a major issue for institutions for the foreseeable future.

For many institutions about to embark on cycles of capital redevelopment, shelving projects has not been an option.  Research from the Association of University Directors of Estates (AUDE) has confirmed that the quality of an institution’s facilities is the most important factor for students when deciding where to study.  An institution’s estate, and particularly its student accommodation offering, is therefore key to its ability to attract students (especially overseas students drawn here by the weak pound) and to thrive post-Brexit. 

Institutions are seeking innovative ways to fund and deliver their estates projects and to limit the levels of funding and development risk to which they are exposed.  At the same time, property investors are seeking low-risk, long-term investments.  There remains optimism in the investment market that, just as it thrived during the last downturn, the student accommodation sector will continue to perform well.  Institutions are currently well-placed to leverage this confidence to achieve their student accommodation strategies.  Student accommodation projects utilising “income strip” models, in particular, are proving to be an ideal vehicle for institutions and investors alike.  

What is an income strip deal and why is it attractive to investors?

An income strip typically involves an institution contracting with a developer/investor, who will forward fund and construct the new development and lease it to the institution (usually for a period of 30-50 years).  The institution pays a fixed rent for this period, which is usually linked to the Retail Prices Index (RPI) or Consumer Prices Index (CPI) (inflation measures) rather than an open market rent.  This indexed review is often subject to a maximum increase, a “cap”, to protect the institution from the spectre of runaway inflation, and a minimum increase, a “collar”, to protect the investor from price deflation.  

The liability for repair and operation of the property usually sits with the institution, along with the future residual value, allowing the investor to “strip” the income out of the asset. The investor benefits from relatively stable long term income which represents 100% of the investment’s return.

The financial strength and stability of Higher Education Institutions, coupled with ongoing market confidence in the student accommodation sector, makes this an attractive investment for investors seeking to minimise their exposure to risk and obtain a safe long-term income. 

What are the benefits for the institution?

An income strip model can offer several benefits to an institution:

  • the forward-funding model provides a funding solution for institutions, who do not have to resort to long-term bank financing on potentially unfavourable terms and who can also minimise their development risk;
  • at the end of the lease term, the institution typically has the option to acquire the freehold of the building for just £1.  This is a key part of the attraction for many institutions.  It may also act as a buffer against exposure to falling property values; 
  • the passing rent the institution pays under the long lease is frequently less than the market rent, enabling the institution to sublet at a rent higher than the rent payable to the investor and allowing it to take a “profit” rent;
  • the capping of the inflation-linked increases in rent provides the institution with cost certainty over a long period of time.

What are the risks for the institution?

Income strips are not risk-free for institutions. 

Where the liability for repair and operation of the property sits with the institution, as it usually will, it is important that the institution has input into the detailed design and specification of the development.  Since the institution will not be carrying out the development itself, a robust construction package, with reliance on warranties for the institution, is important.

Since more than one party will have an interest in the capital value of the property, traditional, predictable lease drafting is often not suitable for income strips.  Issues such as forfeiture, who insures, dealing with rent interruption risks, what step-in rights each party has, and how estate service charges and insurance rent obligations cascade through the structure can make for complications, extensive negotiations and bespoke drafting to ensure that the investments hold up institutionally for the investor, as well as practically for the institution.