The Changing Face of Higher Education

Jack Ablin Market Commentary

Colleges and universities, like most economic sectors, have been turned upside down by COVID-19.  Most schools sent students home early in the spring semester and have been struggling with how to conduct classroom education in this new school year. Unsurprisingly, their plans are mixed. More than half of colleges and universities surveyed expect to convene in person for fall semester, according to data from The Chronical of Higher Education. Another 30 per cent plan to use a hybrid model combining in-person and online instruction. Some of these plans have already been upset. The University of North Carolina, Michigan State and Notre Dame are among several institutions that have backtracked on in-person learning plans as a result of localized COVID-19 outbreaks.

Many of the financial challenges currently faced by colleges were set in motion in long before COVID-19 landed on our shores. In-person classroom teaching has not changed in hundreds of years. College is expensive and its cost structure is inflexible, with tenure and union contracts comprising the bulk of costs. In fact, 60-70 per cent of a college’s operating expenses are channeled to salaries and benefits for employees, including faculty members, administration and staff. Nearly 50 per cent of full-time faculty have tenure, according to industry researcher Scott Galloway, forcing most colleges and universities to depend on tuition payments to meet their operating budgets. As a result, tuition costs have become increasingly unaffordable. Median college tuition in the United States is $24,000 for a public university and $32,000 for a private institution. That’s a stretch for most families in a country where median income is $61,000.  Over the last 10 years, college tuition has expanded at an annualized rate of 3.7 per cent, outpacing medical costs, household income and inflation. Household income has increased at an annualized rate of 2.8 per cent in the interim. At the same time, hiring at degree-granting institutions expanded 10 per cent annually, helping explain part of the cost differential.

College graduates earn a $26,000 annual income premium compared to their high school counterparts. We estimate that tuition payback now takes four years, up from just over two years in 1992. The abrupt shift to online learning has prompted parents and students to question their tuition bills, which were tabulated to reflect an on-campus experience. In a survey of more than 13,000 students by OneClass, 93 per cent of respondents said tuition should be lowered if classes go completely online this fall. Earlier this year, more than 100 lawsuits were filed by students seeking tuition refunds after their classes shifted online. To date, educational institutions remain loathe to provide discounts.

Higher costs and fewer scholarships are partly to blame for the fact that Gen Y are not enrolling in college at the same rate as their Gen X or Millennial predecessors. Last fall 231,000 fewer students enrolled in college than the year before. Higher education headcount has been declining at a 1.5 per cent rate, or about 250,000 students, in each of the last three years, according to the National Student Clearinghouse. Some of the steepest declines occurring in Florida, California and Illinois, together accounting for nearly half of the slide.

Piling onto higher education’s problems, college football could face the prospect of no season this fall.  The Power Five conferences – the Atlantic Coast Conference (ACC), the Big 12, the Big Ten, the Pac-12 and the Southeastern Conference (SEC) – brought in nearly $500 million in TV and radio rights fees last year and another nearly $200 million in post-season events. The Big Ten and Pac-12 announced they are cancelling their respective fall seasons in favor of a spring campaign. Following the Big Ten’s and Pac-12’s announcements, the SEC, ACC and The Big 12 released separate statements saying they will continue moving forward with the season.

Recognizing the financial stress enveloping higher education, Congress enacted the Higher Education Emergency Relief Fund, part of the CAREs Act, which provided $12.5 billion public colleges, private colleges and for-profit colleges to fund their continuing operations. The relief is probably not enough to fill budget gaps. Galloway, using a “value vs vulnerability” analysis, estimates that nearly 100 colleges will close their doors permanently due to a toxic combination of inferior credential value and high tuitions supported by meager endowments. Many more small, private colleges could be shuttered if elite universities leverage online access to expand their slice of a shrinking enrollment pie.

Implications for Investors

Educational services represent a $1.6 trillion industry. A significant retrenchment would undoubtedly ripple through the rest of the economy and financial markets. Public universities collect nearly a quarter of their revenues from state aid, and another 48 per cent is student-generated revenue. By contrast, about 85 per cent of private school revenues are student-generated. Education-backed bonds were among the worst-performing municipal sectors over the last six months, underperforming the broader municipal market by 0.4 per cent, with most of the underperformance coming in the last few weeks. Moody’s Investors Service issued a bleak forecast earlier this year for higher education in America, downgrading it from “stable” to “negative” considering the coronavirus pandemic. Bottom line: It pays to be picky when sifting through educational bond offerings. We recommend emphasizing quality over yield in the interim.

Student housing, and the college towns in which students live, are critical components of the on-campus experience. Both are susceptible to current trends. American Campus Communities, a student housing REIT, plunged 26 per cent from the pre-crisis peak, falling nearly twice as far as the REIT sector overall. Data from Yelp shows businesses in college towns have suffered permanent closures at a rate that’s 24 per cent higher, on average, than the closure rate of their respective states.

Student housing-backed municipal bonds have been generally stable as yields trended lower this year.  Bottom line: Municipal bond investors should review their holdings for bonds issued by college towns, particularly where the number of students dominates local populations, like Ithaca, New York, State College, Pennsylvania and Bloomington, Indiana.

Financial stress often creates opportunities for prudent investors. The challenges that colleges and universities face will likely force many of them to reposition their endowments to raise liquidity to supplement their operating budgets. Nearly half of college endowments nationally are allocated to less liquid, alternative investments like private equity and real estate partnerships. This suggests that many of their private equity partnership holdings could hit the secondaries market, creating interesting investment opportunities for investors willing to provide them with liquidity. Bottom line: consider investing in private equity secondaries as a strategy to play this trend.

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