Morgan Allen, a partner at property firm Gerald Eve, reflects on the considerations in arriving at an opinion of the value of school properties

School properties are enormously rewarding assets to value – they can have a fascinating history with unique characteristics and ethos, and can also include listed buildings in attractive settings.

When invited to quote to value a school property, we identify the property to be valued. Is it freehold or leased, vacant or operating? Is the trading activity mature, failing, or in a turnaround situation?

Purpose of valuations

Defining the purpose of the valuation at the outset is key, as this determines the valuation method to be adopted. The purpose may be for:

• Secured lending.
• Purchase report/investor due diligence.
• Designated advisors report.
• Rent negotiations with a landlord.
• Financial reporting purposes.
• Insurance (building surveyors rather than valuers undertake these, therefore this article will not cover insurance valuations).

Basis of valuation

‘Market value’ is the most commonly used basis. In simple terms, it’s the realisable price between a willing buyer and willing seller after a reasonable marketing period and at arm’s length.

The typical bases of value are:

• Market value assuming vacant possession: This is also referred to as ‘bricks and mortar’ (not a technical term), which assumes the school is closed/vacant. It ignores any business operating from within the property.
• Market value as a fully equipped trading entity: This is also referred to as ‘going concern’. Usually if the school is making a healthy profit/surplus, this figure is higher than the vacant possession value. Generally, expanding school groups prefer to acquire a school which is operating rather than a vacant school, due to the long time lag to reach mature levels of occupancy.
• Fair value is adopted for financial reporting purposes. This usually equates to market value assuming a continuation of the existing use.

Valuation methods

There are various valuation methods, depending on the above (purpose and basis).

• Comparison method – We gather evidence of transactions of schools which are then analysed, adjusted and applied to the subject property on a pound per square foot basis. This is why accurate floor areas are enormously helpful (it can also reduce the cost of a valuation, as one can take check measurements from scaled plans rather than undertaking a full measured survey).

We make adjustments to reflect the size, location, condition, configuration and the range of facilities compared to the subject. We may apply additional sums if the property benefits from sports facilities such as tennis courts, multi-use games areas and astroturf pitches, for example.

We would also apply discounts if there are onerous title or planning restrictions which affect the use of the property (for example, restrictions on pupil numbers).

• Profits method – This method is used to value the trading activity which operates from the school property. (It is also used for trading properties such as hotels and care homes).

Transactions of trading schools fall into two categories:

• Profitable schools selling to for-profit providers under which the Fair Maintainable Operating Profit (FMOP) is capitalised, which can be similar to EBITDA, commonly, for freehold schools, at years purchase multiples (or market-based yield) of between about eight-times and 13-times (inside London). A deduction for catch-up capex may be required The higher multiples would tend to be in London and affluent Home Counties, and,

• Asset sales out of a charitable trust, where the school is operating at a deficit and is no longer financially viable without external third party investment. In this case, the key driver of the value as a trading entity is the underlying vacant possession value of the property assets, making allowances for working capital and investment requirements to transition the business to expected levels of profit, for example, a turnaround which could take two-to-three years. In this instance, the value as a trading entity would be less than the vacant possession value.

In the current climate, there is generally less demand for turnarounds and a greater divergence of values, that is, good demand for well-performing schools and perhaps only several buyers for failing schools operating with a substantial deficit.

Information gathering

A valuer will request two years audited accounts, the current-year budget, forecast, pupil numbers, fee schedule and the staffing schedule. This is part of our information gathering, investigations and due diligence. We will ask to see competitor fee analysis in order to benchmark the fees. With the threat of VAT on school fees, we suspect that parents will now shop-around and want value for money, which may see enrolment fall in due course, particularly if the school is situated in a competitive location.

We assess the income that could be generated by a ‘reasonably efficient operator’.

We make deductions for expenditure, staff costs and other running costs. We benchmark/sense-check our assessment of revenue and profit against the previous accounts, the current-year budget, and our own knowledge of schools’ trading performance. We check the amount for repairs and maintenance and make a further allowance for sustaining capex.

We thus arrive at our assessment of FMOP, which may be equivalent to EBITDA. We then apply a capitalisation yield (years purchase multiplier), which we derive from sales of other trading schools. This produces the market value as a fully equipped trading entity.

We may need to make an additional deduction if the school buildings require catch-up capex (that is, more than sustaining capex). That is, market value, plus a deduction to bring the property into repair.

Profits method – considerations

• Is the school in a competitive environment?

• Is it over- or under-performing?

• Could discounts be reduced, or staffing costs perhaps?

• Is there scope to increase fees and expand pupil numbers, perhaps via development/expansion, opening a nursery, or going co-ed?

Discounted cash flow 

A discounted cash flow involves projecting cash flows over an assumed period (usually between five and ten years), plus an exit value. This method is used when a school is not operating at full potential, that is, if the school:

• has only recently opened or has potential to grow enrolment or increase fees (although the potential to increase fees by a material amount is less likely with the threat of VAT on fees).
• has had a fall in pupil numbers, but has potential to recover to previous levels.

Typically, a for-profit operator would seek to grow profit via a combination of increasing revenue (fees and/or pupil numbers) and reducing expenditure.

A for-profit school operator would seek to reduce overly-large discounts gradually. However, this can’t be done overnight, as staff discounts may be required to attract and retain key staff. Fees, staff costs and other costs are then inflated over the period, while overly-generous discounts are brought down, and any big capex projects accounted for in the cash flow.

The cash flow is then discounted back to the present day at a discount rate (desired rate of return).

• Investment method – This method is used when a property is producing rental income, which is capitalised to produce a gross capital value and a deduction made for purchaser’s costs. It may be prudent for the valuer to make an allowance for a letting void and rent-free period if there is less than five years until a tenant break or lease expiry.

• Residual method – A vacant or surplus school asset may have development potential for a higher-value alternative use. If this is the case, the residual method of valuation is used to calculate the ‘land value’, which assumes it has planning permission for a development. It can be highly speculative without a planning consultant and architect’s advice on feasibility.

The valuer assesses the gross development value (GDV), which is the aggregate of sales rates of any flats and/or houses (or other commercial property types) which could be accommodated on the site, factoring in any affordable housing requirement. From the GDV, one deducts build costs plus a contingency, S106/CIL costs to the local authority, professional fees, finance, and any other costs. The residual land value can then adjusted for planning and other risks.

We would then cross-check this with comparable evidences of land sold with planning permission, on a price per acre and a price per unit basis.

Note: School uses are often protected by planning policy as ‘community uses’ and their loss resisted by councils. However, if school property become surplus and there is no demand for continued use, a council may consider alternative uses. Typically, a council would want to see a lack of demand demonstrated via a marketing campaign before considering alternatives.

Flaws with the residual method:

• Relies on accurate information.
• Highly sensitive to inputs and minor adjustments.

Thus, we run a sensitivity analysis, that is, if we assume the sales rates drop by 5%, and/or the build costs increase by 5% or 10% – what affect this has on the land value and would a hypothetical development then become unviable?

• Depreciated replacement cost – This is used for specialised buildings which rarely or never sell in the market. It is typically used for valuations for financial reporting purposes or for business rates.

The approach is based on the current cost of replacing an asset, less deductions for physical deterioration, obsolescence and optimisation, and the cost of the land.

• Reinstatement cost assessment – Banks request this to check if the buildings are adequately insured. This figure is rarely close to the actual market value of the asset. It is important not to confuse this with ‘market value’. A valuer’s estimate of a reinstatement cost assessment cannot be used for insurance purposes. This is a different exercise which would be undertaken by a building surveyor rather than by a valuer.

In summary, valuing school property can be relatively opinion-led, but an approach which includes a review of comparable evidence, an assessment of the trading potential, and development appraisals to estimate the alternative use value is a solid basis for arriving at an opinion of value.