Issues for the school estate
Morgan Allen and Rhiannon Klein of property specialists Gerald Eve outline the potential issues ahead for managing the school estate
The affordability of fees for parents, set at odds with budgetary pressures faced by schools in a competitive environment, remains a primary concern for all independent schools.
The 2022 Independents Schools Council annual census showed that fees rose in the year by a national average of 3%, up from 1.1% in the previous year (which was historically low due to the pandemic). This was the second lowest fee increase since 2000.
Anecdotally, we estimate that average fee increases in September 2022 were in the order of 5%.
With inflation nearing 10% and the continuing need to invest in school facilities in order to enhance parent- appeal and attract and retain pupils, bursars and finance directors are currently facing the challenge of setting fees for September this year that strike an appropriate balance.
Labour’s plans to impose VAT on independent school fees and remove charitable status could come at a critical time for independent schools (many of which are charitable schools), and we anticipate this will further increase the divergence between the strong and the struggling independent schools.
It’s unlikely many schools will be able to pass on the VAT liability on fees in full to parents and therefore schools, in the short term, would need to absorb some of the cost. For schools making a limited surplus, or where pupil numbers are declining, this could pose a real challenge. With a Labour government looking increasingly likely, it is prudent for schools to prepare scenarios in their business plan which forecast the impact these changes could have on trading performance.
The loss of charitable status would mean the loss of charitable relief on business rates of up to 80%, resulting in a significant increase in fixed annual costs for most schools. Potentially, the withdrawal of charitable relief, combined with the introduction of VAT on fees, could dampen the rental market for schools which could in turn reduce rateable values at the next rating revaluation in 2026. It’s worth also noting that the draft rateable value figures have now been published for April 2023. All schools should be aware of their new rateable value and how this will translate into payments from 2023-24 so that they can budget accordingly. We are awaiting further details of individual draft valuations for school clients, so that we can analyse these and, where appropriate, embark on a new appeals process.
However, we are still very much in the thick of working through appeals against the current rateable values, with some large savings for schools being achieved backdated to 2017, with the deadline for submitting 2017 list appeals rapidly approaching on 31 March this year.
It’s not all bad
Most independent schools currently pay VAT on their expenditure and don’t have the ability to reclaim VAT, as businesses do, which would change if their VAT status were revised. Schools undertaking major capital projects and upgrading school facilities would be able to recover VAT incurred on expenditure and the school may be able to claim back some or all of VAT paid on large capital expenditure projects in the previous 10 years from the date of registration. However, this benefits the stronger, well-funded schools which have had, and continue to have, the capital and resources to invest in their sites.
Furthermore, in the unfortunate event that Labour’s proposed measures results in school closures, it’s more likely that the majority of pupils (at least in affluent locations) will remain within the private sector, relocating to the closest, ‘best’ alternative independent school. This is somewhat ‘last man standing’, with the more successful schools hopefully benefitting from increased occupancy as weaker schools close.
The independent schools market has been characterised by continued consolidation for many years now and we have seen an increased number of mergers and acquisitions since the pandemic.
Weaker schools which may struggle with Labour’s proposed measures may consider the benefits of a merger. Groups have been able to benefit from economies of scale, particularly in forming geographical clusters, pooling expertise, and have enhanced their market share in an increasingly competitive market.
Rising interest rates, higher cost of debt and lack of availability of debt/finance has put further pressure on some schools’ ability to undertake new building projects or invest in teaching facilities. However, there may be many opportunities for independent schools to realise capital from their estate. We have been involved in a number of sale and leasebacks and ground rent disposals, which can be an innovative way of raising valuable capital for schools without impacting upon trading operations. Many schools may also have surplus assets that can either generate income or be disposed of to release capital.
Despite the challenges many schools are facing, market activity indicates that operators foresee a reasonably stable demand for independent schooling. The high quality of teaching delivered throughout the pandemic has attracted new parents from the state sector, coupled with some localised improvements in supply and demand characteristics following several school closures in 2020-21.
Investors and funds continue to be attracted to education as a needs-based sector, when compared against more volatile traditional property markets. The characteristics of the sector are such that investors see opportunities in being able to purchase long-term cash flows, generated by a school’s business, secured on good and often freehold properties.
There has been continued interest from for-profit groups for schools either trading well or with good growth potential. Values and appetite from buyers for well-performing schools have generally remained strong, however in the current uncertain market, we are seeing less appetite for turnaround situations unless the school facilities, socio- economic characteristics of the area, and growth potential can be seen to outweigh potential risks. The underlying vacant property values in turnaround situations will be key for buyers and their funders.
Morgan Allen is a partner and Rhiannon Klein is an associate at Gerald Eve.