Morgan Allen outlines some of the challenges related to property and its management faced by independent schools and how they can be addressed

 

1. Protecting assets

The imposition of VAT on school fees is almost certain under a future Labour government, which is adding considerable uncertainty to the independent schools sector. Some schools are seeking to protect their assets by entering into property company/operating company (PropCo/OpCo) arrangements, under which a lease is put in place.

We would strongly recommend that expert independent property advice is sought on the detailed lease terms. These can have material implications for the value of the interests, control, securing mortgage funding and other such matters.

2. Releasing capital

The need to invest in school facilities in order to enhance parent-appeal (with ever higher expectations) and attract and retain pupils is a constant issue at most independent schools. Inflation and budgetary pressures have affected some schools’ ability to undertake new building projects. However, there are a number of options for schools to realise capital from their estate to invest back into facilities.

Debt funding through secured lending founded on a realistic business plan remains the ‘go to’ for many schools. While the cost of debt has increased, there are still a number of lenders active in the market and we are beginning to see a recovery in the number of secured lending valuations being undertaken of schools. That said, the main clearers generally prefer to lend to their existing borrowers rather than lending to ‘new to bank’ school borrowers.

We’ve seen a number of the challenger banks show increasing appetite to lend into the schools sector, although their margins (interest rates) tend to be more expensive than those of the top high street banks.

Having a ‘red book’ valuation prepared by a valuation firm that is immersed in the schools market is key.

Schools facing a refinance of existing debt in the next couple of years are likely to find that lenders will demand to see robust stress-testing of forecast cash flows to ensure that in the unfortunate event there’s a decline in pupil numbers (turnover), the school’s trading activity could still amply cover the repayments.

In addition, loan-to-value ratios have declined, at the same time as interest rates have increased; this means that it now costs more to borrow less. Schools which are already highly leveraged may struggle to refinance over the next couple of years.

A sale and leaseback is an established method of releasing capital from property, whereby the occupier would sell the freehold asset to an investor and simultaneously take a lease back for a fixed period of typically 15 to 35 years at a market rent. A ground rent disposal is a lower risk option for both the occupier and investor and can provide schools with long-term security of tenure with the potential to recover the freehold for a nominal sum after say, 50 to 75 years. The leaseback period in a ground rent deal is generally 100 to 150 years at a much lower, sustainable rent.

This can be an attractive funding option for those with weaker credit profiles/covenant strength and those requiring a commitment to the property for the foreseeable future. That said, if a school is struggling, investor appetite might be muted. There would be virtually no investor appetite for a loss-making school.

Many schools may also have surplus assets that can either generate income or be sold to release capital. This may take the form of surplus land within the school estate, underutilised staff houses and/or surplus school buildings that you may be able to sell or lease to another user.

Finally, there have been a growing number of mergers and acquisitions in the schools market in recent years. There are opportunities to explore mergers, joint venture or shared services opportunities to improve economies of scale, pool expertise and enhance market share in a more competitive market. A merger would offer the opportunity to reduce often expensive ‘head office’ costs, via reducing duplicated roles such as a bursar, marketing, payroll, etc.

We expect forward-thinking bursars will have already stress-tested forecast cash flows to account for VAT on school fees and the potential impact this may have on pupil numbers. Bursars and governors are likely to have considered or even approached other schools to discuss opportunities for mergers.

3. Diversifying income

Buying or merging with a feeder school offers a good way to protect a future pipeline of pupils.

We are also seeing schools create nurseries (if they don’t already have one) to protect the pupil pipeline into reception. Furthermore, early years will not attract VAT. Introducing a nursery would boost income and also diversify income streams.

Very careful consideration would need to be given to the model of nursery, for example, term-time only, or full 51-week wraparound day care. We have seen schools introduce a term time-only nursery and then struggle to fill places in catchments where parents require full wraparound day care instead, and then fail to transition to such a model successfully. A hybrid sessional nursery school and wraparound day care model is often inefficient.

We would strongly recommend to a school considering introducing a nursery that you obtain a report on the catchment analysis and population projections, to ensure a proposed nursery would have sufficient demand to fill places and to decide which type of model to adopt. We would be pleased to recommend a specialist for a catchment analysis report.

Fees for pupils with an education, health and care plan (EHCP) will not attract VAT. We therefore predict a huge surge in parents seeking referrals for EHCPs in order to mitigate the cost of tuition fees. Schools might want to consider bolstering their SEND departments in due course to meet this predicted increase in demand.

4. Project management

School estates are continually evolving in response to changing educational priorities, the need to replace outdated infrastructure, to create more flexible accommodation, or to add new facilities.

While new projects are exciting and are enthusiastically welcomed by governors, parents and staff, for the bursar they can be a time-consuming diversion from day-to-day responsibilities, particularly where they have little previous experience of running construction projects or the many decisions that are required.

In recent years we’ve seen an increasing number of independent schools appointing an external project manager to lead the process and to provide a single point of contact with the professional and construction teams, allowing the bursar to concentrate on strategic issues.

While projects vary in their complexity, in our experience the key issues of the moment can often be distilled into the following:

• Estate strategy: before embarking on any major capital project, it is important to understand how that project fits within the longer-term plans for the school, to ensure that classrooms meet the future needs of the curriculum, that obsolete facilities are replaced at the end of their life, and that the wider infrastructure is sufficient to support future plans. The estate strategy should clearly set out the school’s vision for the future and the overall timeline and budget within which individual projects are to be developed.
• Governance: projects require input from an array of external advisors but also input from a cross-section of internal teams to include teaching, facilities and IT, together with governor support. Establishing a project steering group at the outset with representation from all, and input from the external project manager, is the right forum for key decisions and consistent reporting.
• Brief: the brief for any project should clearly set out the key deliverables, milestones, budget and programme. Crucially, it should help avoid ‘scope creep’ as the project develops.
• Programme timing: the majority of problems that occur on any project are due to unrealistic expectations about the programme, particularly with the length of lead-in and design periods. Schools have short windows within school holidays to carry out disruptive works in existing buildings and critical dates to hit with the start of term. Many independent schools are located in historic and listed buildings which adds further complications. A disciplined approach to programme management is needed at the outset.
• Budget: construction costs, as elsewhere, are currently at an all-time high and agreeing fixed price contracts is becoming more challenging. In addition to the build costs, there are also site investigations, professional fees, enabling works, temporary facilities and VAT which can add 40 to 50% to the overall cost.
• Environment, sustainability and governance: ESG is no longer just aspirational. Recent increases in energy costs, for example, are biting and parents and children want to know what schools are doing to address environmental concerns in their long-term planning. New projects also need to be sustainable in the widest sense by being flexible and accessible to all.

One of the few positives of VAT being imposed on school fees is that schools embarking on capex projects would now be able to reclaim the VAT on the costs of construction, thus reducing construction costs by 20%.

5. VAT

The imposition of VAT on school fees has the potential to affect independent schools across the country significantly. While the idea of introducing VAT on education has long been a topic of discussion on the political agenda, it remains unimplemented for now. However, a Labour government, and thus VAT on fees, is looking increasingly likely.

Plenty has already been written and debated on the impact of VAT on school fees, so we won’t debate it further in this article. In short, adding VAT to school fees is likely to have adverse effects on independent schools. It will strain many parents’ finances, increase administrative burdens for schools, and potentially limit the availability of scholarships and financial aid. Policymakers would need to consider carefully the consequences of such a move on the education landscape in the UK before implementing any changes.

The future

The next couple of years will be a bumpy ride for many, with the weaker, smaller schools suffering the most. Savings can be made on capital expenditure projects if VAT can be reclaimed. Business rates can be appealed; we have achieved substantial rates refunds for some of our school clients.

We predict a greater number of mergers and opportunities for the for-profit groups to acquire schools and for further consolidation in the sector. We are aware that many of the schools groups are being contacted by sometimes desperate bursars on a weekly basis. But with more opportunities, the groups are now more discerning about their acquisitions.

Values have dropped from the heady values of 2022 and there’s a greater divergence of prices being paid between the strong and weaker schools. Schools making a very substantial deficit might struggle to find a buyer at all.

We advise schools groups on acquisitions and/or valuations and can provide advise on the potential market for a school as a going-concern, if this is being considered.

 

Morgan Allen is a partner at real estate advisor Gerald Eve.