landmark brief: charter school facilities finance strategy update 2013

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What every charter school leadership team and board needs to know about current market and product developments for charter school facilities financing in order to assess true costs, risks and opportunities.

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  • What every charter school leadership team

    and board needs to know about current

    market and product developments for

    charter school facilities financing in order to

    assess true costs, risks and opportunities.

    BRIEF: Charter

    School Facilities

    Finance Strategy

    Update

    June 27, 2013

    Ted Fujimoto

  • Landmark Consulting Group BRIEF: Charter School Facilities Finance Strategy Update

    June 27, 2013

    Copyright 2013 All Rights Reserved. Landmark Consulting Group, Inc. www.ConsultLandmark.org 1 | P a g e

    Overview The charter school sector is over 20 years old and yet the majority of school leaders have not developed

    strategies to have reliable ways to obtain facilities and facilities financing. We believe the lack of

    facilities financing solutions has a larger negative impact on school quality and stability than realized.

    Implementing a high quality school design and operating system takes focused time and resources.

    Every minute taken away from implementing a strong school design and running effective school

    operations compromises the very thing that is supposed to enable charter schools to outperform. Every

    miscalculation of facilities timing and cost takes away precious resources needed to launch and operate

    the school. With these challenges, even the most experienced school teams struggle to create strong

    school launches due to the amount of time and resources spent on securing facilities.

    It is unacceptable that many charter schools secure facilities only months and sometimes days before

    opening caused by facilities financing fails to materialize at the last minute leaving only a few months to

    acquire, build and/or renovate a school building or by inexperienced and unsophisticated decision

    making on the schools part.

    As with any developing and emerging sector, the charter school facilities finance landscape is messy

    both on the buyer side (charter schools) and on the supplier side (financiers). On the financier side,

    early facilities financing solutions were not well designed to fit to the needs of charter schools and had

    limited amount of financing capacity (dollars available for financing.) On the buyer side, charter school

    leaders generally lacked sufficient commercial real estate development and financing experience. They

    also had a limited ability to understand the true risks and costs of these facilities finance solutions and

    financiers were not helpful enough to help them understand these risks and costs.

    Today, charter school leaders are more familiar with the various facilities financing products and tools

    such as bond financing, bank financing, credit enhancements, new markets tax credits, short-term

    leases, and long-term leases. Some larger charter school groups have been developing sophistication in

    the long-term facilities planning. However, we have found that many still have a limited understanding

    of the risks, true costs, and tradeoffs of each and how to create a comprehensive financing strategy that

    combines the use of a variety of solutions at the right time. Each solution of a particular type is not all

    created equal. Every one comes with features and risks.

    The purpose of this whitepaper for charter school leaders is to:

    1. Be informed about facilities finance product and tool developmentsincluding features, market

    trends and risks.

    2. Explore strategies to grow charter schools in a more controlled, deliberate and planned fashion -

    leveraging the best combination of financing products and tools at the right time.

    We hope that this will help charter schools develop and execute strategic plans that create the highest

    quality charter schools at a quicker pacebenefitting more students and increasing their achievement.

  • Landmark Consulting Group BRIEF: Charter School Facilities Finance Strategy Update

    June 27, 2013

    Copyright 2013 All Rights Reserved. Landmark Consulting Group, Inc. www.ConsultLandmark.org 2 | P a g e

    Market Developments We believe that, overall, charter school leaders have had a tendency to underestimate timing,

    availability/capacity and cost risks of financing products.

    Some macro market developments to consider include:

    1. Bond rates escalating from rising interest rates and accumulation of charter school bond

    defaults and downgrades. Implication: Actual cost of bond is a lot higher than what school

    leaders perceive.

    2. Bond deals are collapsing at the eleventh hour even with schools that have successfully issued

    bonds in the past. Implication: Do not count on a successful bond issuance and have a backup

    plan.

    3. Long-term lease financing solutions are maturing and their rates are declining - becoming

    competitive with the top 30% rates of the bond market. Implication: The flexibility and

    predictability of this capital may make this method more attractive than a bond.

    4. New Market Tax Credits continue to be volatile and available to only certain schools. In 2013,

    there are some New Market Tax Credits available, as there were prior to 2012. This is in stark

    contrast to 2012 when there were almost no New Market Tax Credits available to charter

    schools. Implication: If New Market Tax Credits are available to your school, apply for them but

    look to other forms of financing as the primary plan and New Market Tax Credits as the

    secondary plan.

  • Landmark Consulting Group BRIEF: Charter School Facilities Finance Strategy Update

    June 27, 2013

    Copyright 2013 All Rights Reserved. Landmark Consulting Group, Inc. www.ConsultLandmark.org 3 | P a g e

    5. Bank loans are becoming more available. A number of banks have been aggressive in providing

    low interest loans with low equity requirements in certain regions but have a limited amount

    they are willing to lend to charters and within a concentrated geographic region. Most banks

    have high bar credit criteria and require substantial equity of 20-30%. Most bank loans are

    typically for a 5-7 year period. Implication: Evaluate the cost of bringing 20-30% equity to the

    table plus very high risk of higher interest rates after the loan term when you have to refinance.

    You may want to consider other long-term financing including long-term lease arrangements

    that may actually have a lower cost over the long-term and not have the equity requirements

    and associated costs.

    6. Credit enhancement programs are useful across bank loans, bonds and long-term lease

    financing packages to lower the cost of financing, lower the equity requirement and/or qualify

    the school for financing it would otherwise not qualify for. Credit enhancement programs in the

    past have limited remaining capacity and some are attempting to rebuild this capacity.

    Implication: Make sure the provider has capacity for your deal and find out what their process

    and timing are. Check with the bank, bond, long-term lease financier to make sure the credit

    enhancement is acceptable early in the process as their criteria is getting more stringent.

    Product Specific Considerations School leaders should take the following factors in consideration in evaluating opportunities and risks

    using various financing products and tools:

    Bonds Can be the lowest cost option when used at the right time

    - Cost Uncertainty Risk: Bond rates and costs are higher than expected. Schools have no control

    and no way to know ultimate cost of the bond until just before the bond offering. Currently,

    bonds costs are trending higher, driven by forecasted higher Federal Reserve interest rates and

    an escalated number of defaults and downgrades of existing charter school bonds.

    - Timing Uncertainty Risk: Bond offerings may be aborted at the last minute due to lack of

    market. There are a number of recent bond deals that have fallen through at the eleventh

    hour even for some well-established charter schools.

    - Financing Capacity Risk: Bond covenants will prevent flexibility of future growth and additional

    financing. A school is likely to be restricted on how much additional debt is allowed. This means

    that the school may have restricted ability to obtain other sources of financing at a later date

    without paying off the bond first. Another common restriction is that the bond takes priority

    over other creditorswhich are often not acceptable to other creditors.

    - Qualification Risk: Schools must have sufficient credit capacity to be able to obtain bonds that

    are credit rated high enough to get reasonable rates.

    - Building Cost Risk: Certain types of bonds may require that the charter school adhere to public

  • Landmark Consulting Group BRIEF: Charter School Facilities Finance Strategy Update

    June 27, 2013

    Copyright 2013 All Rights Reserved. Landmark Consulting Group, Inc. www.ConsultLandmark.org 4 | P a g e

    school building codes which in some cases may be a 30-100% higher cost of construction than a

    similar building for a private school.

    - True Cost: In addition to the coupon rate, a school must factor in fees and expenses (all in cost)

    PLUS the additional costs of capital incurred to finance reserve funds which can be between 10

    to 15 percent. In other words, a school may need to borrow 10 to 15 percent more than it

    needs and is paying extra cost. Credit enhancements may be used to reduce the cost of a bond.

    - Best Use: Bonds are best used when (a) the school or schools have been in operation for 10+

    years, (b) there is a large enough portfolio of school buildings and/or sites to be financed, and

    (c) the school has no or very little additional expansion plans requiring future rounds of

    financing.

    Bank Loans Medium priced option but only with credit and lots of equity

    - Cash Flow Risk: Bank loans usually require a significant amount of 20-30% of equity. This will

    potentially require a school to tie up its precious cash and grant money in a facility and away

    from operating and startup costs.

    - Interest Rate Risk: Many loans are based on an adjustable interest rate. Interest rates are likely

    to go up significantly over time increasing the cost of the loan and decreasing the cash flow of

    the school.

    - Timing Uncertainty Risk: Many bank loans may require a refinancing or balloon payment in the

    futuretypically 5-7 years. The charter school has no control of the financial markets and

    whether it will be able to refinance with favorable terms at that point in time.

    - Financing Capacity Risk: Bank loan terms may prevent flexibility of future growth and additional

    financing. A school is likely to be restricted on how much additional debt is allowed. This means

    that the school may have restricted ability to obtain other sources of financing at a later date

    and may have to refinance each time. Another common restriction is that the bank loan takes

    priority over other creditorswhich may not be acceptable to other creditors.

    - Qualification Risk: Schools must have sufficient credit capacity to be able to obtain bank loans

    that are rated high enough to get reasonable rates.

    - True Cost: In addition to the interest rate, a school must factor in fees and expenses (All in cost)

    PLUS the additional costs of capital incurred to finance or obtain the 20-30 percent equity funds.

    Credit enhancements may be used to reduce the cost of the bank loan.

    - Best Use: Bank loans are best used when (a) the school or schools have been in operation for 7+

    years and (b) properties as smaller and/or at a lower cost, (c) the school readily has the ability to

    bring in low-cost equity, and (c) the school has no or very little additional expansion plans

  • Landmark Consulting Group BRIEF: Charter School Facilities Finance Strategy Update

    June 27, 2013

    Copyright 2013 All Rights Reserved. Landmark Consulting Group, Inc. www.ConsultLandmark.org 5 | P a g e

    requiring future rounds of financing.

    New Market Tax Credits One of the lowest cost of financing, if available

    - Timing Uncertainty Risk: New Market Tax Credits may not be available when the charter school

    needs it. Charter school leaders overestimate the availability of New Market Tax Credits and

    underestimate the volatility. Last year, very few - if any - New Market Tax Credits were available

    to the charter sector but this year they are available again.

    - Financing Capacity Risk: Providers have only so many New Market Tax Credits available.

    - Best Use: Use other forms of financing as the primary plan and New Market Tax Credits as the

    secondary plan.

    Short Term Leases Great for small temporary spaces

    - Cost Uncertainty Risk: Costs may escalate at the renewal period of each lease. The amount of

    escalation is not necessarily known up front.

    - Timing Uncertainty Risk: As the school grows, there may not be sufficient space to grow into

    when the school needs it.

    - Occupancy Risk: There is no guarantee that the space will be available to the school at the new

    renewal.

    - Building Cost Risk: Tenant improvements may not be allowed by the owner or buildings may

    need significant tenant improvements that are not recoverable when the school decides to

    move elsewhere.

    - True Cost: In addition to lease rate, the cost of tenant improvements and the cost of capital for

    any required deposits should be factored in.

    - Best Use: Short Term Leases are great for small schools, schools in their first year or two of

    existence or in facilities that are below market rents.

    Long Term Leases Useful default financing for expanding and new schools

    - Cost Risk: Costs are actually aligned with the upper end of the bond market but without the

    restrictions of a bond or a bank loan. Lease agreements often escalated their rates to mirror

    interest rates. Long Term leases are offered by some providers to be structured as a mortgage

    to reduce or eliminate property tax costs.

    - Timing Uncertainty Risk: Some leases may require a refinancing/buyout after Year 7. The

  • Landmark Consulting Group BRIEF: Charter School Facilities Finance Strategy Update

    June 27, 2013

    Copyright 2013 All Rights Reserved. Landmark Consulting Group, Inc. www.ConsultLandmark.org 6 | P a g e

    school has no assurances that it can qualify for other forms of financing. It is important to have

    terms that the school (not the financier) has the option to refinance or do a buyout after 5+

    years.

    - True Cost: In addition to the lease rate, the cost of any equity needed should be factored in as

    well as cost of property taxes and maintenance. In addition, the cost of a buyout should be

    considered. Some leases have an escalating buyout premium over the length of the lease based

    on fair market value or cap rate. Other leases have a declining buyout premium over the length

    of the lease.

    - Best Use: Long Term Leases are great to provide a baseline financing program for any quality

    charter school group that has expansion plans for one or more schools until a large portfolio can

    be refinanced using bonds and/or New Market Tax Credits. This is the most predictable and

    stable capital available with the largest capacity.

    Credit Enhancement Useful in conjunction with bonds and mortgages to lower

    costs of financing

    - Financing Capacity Risk: Providers have a limited amount of credit enhancement capacity

    available at a given time.

    - Best Use: Use it in conjunction with bonds, long-term leases, especially bank loans to lower

    financing costs. Always have a backup plan if the credit enhancement provider does not have

    enough capacity.

    Free or Low Cost Buildings Great option if they are appropriate buildings in the

    right location

    - Timing Risk: The charter school has no control of the availability of these buildings. This may

    cause the charter school to have to delay opening.

    - Cost Risk: Free or low cost buildings are not necessarily cost-free or even low cost. Costs to

    consider include extra maintenance for ill-maintained and older buildings, utilities,

    transportation and costs of renovation, etc.

    - Operating Risk: The building design may not fit the needs of the charter school or have

    operating restrictions if it is shared with other tenants that have operational impact on the

    charter school. Recruitment and enrollment of students may be more difficult if not located

    properly.

    - Best Use: Use in conjunction with district school conversions or serving neighborhoods where

    districts or private schools have shut down schools within.

  • Landmark Consulting Group BRIEF: Charter School Facilities Finance Strategy Update

    June 27, 2013

    Copyright 2013 All Rights Reserved. Landmark Consulting Group, Inc. www.ConsultLandmark.org 7 | P a g e

    Potential Strategic Options Charter school teams develop a school design, acquire authorization, raise funds, launch a school,

    implement the design and operate the school all a huge effort. To add the uncertainty of the ability to

    secure school facilities on top of these issues often becomes the last straw. A solid strategy

    accomplishes the following:

    1. Creates a path with a high degree of confidence that a charter school is able to obtain the

    facilities it requires both at the start and when it expands.

    2. The financing strategy optimizes the cost of capital to the lowest cost over time without creating

    constraints that prevent a school from growing as planned.

    3. Financing is sensitive to cash flow constraints for the first few years of a startup school until they

    reach full enrollment.

    4. Requires very little equity or no equity to be tied up in facilities that would negatively impact the

    operating cash flow and reserves of the school.

    5. Allows for schools to refinance within reasonable time periods at a given price with the schools

    (not the financiers) option.

    Formal Layered Program Approach

    The Formal Layered Program approach is for charter and education management organizations that

    have ambitious plans for continuous expansion. Layer 1 establishes the baseline foundation method of

    financing facilities. Each higher layer may have greater risks of execution but with lower costs of capital

    payoffs which, if successfully obtained, can be used in replacement of the baseline financing method.

    Layer 1 Long-Term Lease

    Establish a long-term lease program as the default method of financing for new projects. In partnership

    with the right real estate development firm and real estate fund, the equity requirement may be 0% to

    10%.

    Layer 2 New Market Tax Credits

    Pursue available New Market Tax Credits to see if any of the school facilities projects could be financed

    using this method in replacement of the Long-Term Lease program. This is more useful for smaller

    projects.

    Layer 3 Bank Loans with Credit Enhancements

    Identify any potential special bank loans with credit enhancements and low equity requirements that

    could be at a lower cost of capital than the long-term lease program.

  • Landmark Consulting Group BRIEF: Charter School Facilities Finance Strategy Update

    June 27, 2013

    Copyright 2013 All Rights Reserved. Landmark Consulting Group, Inc. www.ConsultLandmark.org 8 | P a g e

    Layer 4 Bonds

    Work on large issue bonds to take out seasoned properties (7 to 12 years) from the long-term lease

    program and any bank-financed properties that have higher capital costs.

    To optimize facilities costs per pupil, schools should ramp up to full capacity within 2 years, no more

    than 4 years. It is also possible to expedite the fill-up of a building by launching multiple schools on the

    same campus and in the future by either adding on new buildings to that campus if there is sufficient

    land space or building new campuses at a different location.

    Build-Out Program Approach

    The Build-Out Program approach is designed for single schools or schools with limited expansion

    ambitions. The basic idea is to mirror the facilities Build-Out to match as closely as possible the needs of

    the school each year as they add new grade levels. This approach works best when a school is able to

    reach full enrollment within 2-3 years of opening.

    Stage 1 Property Acquisition and First Building

    Using long-term lease financing, acquire a reasonably priced property. A building must either be built or

    may be remodeled that is sufficient to house the first year or two of enrollment but not more. The first

    payment of the long-term lease should be delayed until January of the first school year of operation

    thus cutting the first year capital costs in half.

    Stage 2 Expansion Building

    In Year 2, another building is constructed to house the remaining schoolalso using long-term lease

    capital.

    Stage 3 Refinance

    After the buildings have been seasoned (5-12 years), the school identifies any lower cost sources of

    capital (loans, bonds, New Market Tax Credits) to refinance out of the long-term lease without

    compromising and depleting operating cash reserves.

    Deferred Slow Growth Approach

    The Deferred Slow Growth approach is designed for single schools or schools with limited multi-site

    expansion ambitions and slow enrollment growth.

    Stage 1 Short-Term Temporary Lease

    Identify temporary short-term lease facilities sufficient to accommodate the first few years of

    enrollment.

  • Landmark Consulting Group BRIEF: Charter School Facilities Finance Strategy Update

    June 27, 2013

    Copyright 2013 All Rights Reserved. Landmark Consulting Group, Inc. www.ConsultLandmark.org 9 | P a g e

    Stage 2 Long-Term Lease or Credit Enhanced Bank Loans

    Once the school reaches 75% full enrollment, start acquisition and building of permanent long-term

    facilities using long-term lease capital or credit-enhanced bank loans.

    Stage 3 Refinance

    After the buildings have been seasoned (5-12 years), the school identifies any lower cost sources of

    capital (loans, bonds, New Market Tax Credits) to refinance out of the long-term lease without

    compromising any needed operating cash reserves.

    Conclusion The most important thing a charter school can do to establish a coherent growth plan is to have a well-

    defined facilities strategy that is mostly in the direct control of the school.

    Facility delays create enormous opportunity and organizational cost both on school quality and

    financially. Each year the school is not able to meet enrollment goals, revenues are left on the table.

    Each school that didnt open in the specified timeframe delays reaching the financial cash flow break-

    even and sustainability point. Considering these potential consequences, finding facilities financing

    solutions that remove this uncertainty even if it costs a little more can be worthwhile. For example,

    many charter management groups run a negative $500K to $1M in cash flow per year until they have

    enough schools with sufficient enrollment to reach their breakeven pointe.g. 12-15 schools. Every

    year of delay in reaching this breakeven point can be costing the organization nearly a million dollars

    cash flow. Paying a 0.5% to 2% more for financing that removes the facilities uncertainty and enables

    the organization to execute as scheduled may more than pay for itself.

    We recommend that charter school leaders take a layered or staged approach to financingalways

    starting with the most predictable form of capital and facilities options (e.g. long-term lease) and then

    simultaneously pursuing other reasonable secondary lower cost options. If one of these secondary

    options is viable, then the school always has an option to replace the long-term lease option with the

    lower cost option.

  • Landmark Consulting Group BRIEF: Charter School Facilities Finance Strategy Update

    June 27, 2013

    Copyright 2013 All Rights Reserved. Landmark Consulting Group, Inc. www.ConsultLandmark.org 10 | P a g e

    About Landmark Consulting Group, Inc. Founded in 1988, Landmark Consulting Group helps create, launch and

    grow high impact education organizations, projects and programs that are

    quality, innovative, sustainable, and scalable. Our clients have created or

    transformed 1,100 schools, impacted the lives of over 360,000 students

    and raised over $150 million in philanthropy support. We have worked

    and supported more high performance school models and school

    networks than anyone in the country.

    For school organizations, we can help you codify your school or program

    model, design and implement an effective replication system, plan for

    quality growth that is sustainable, and/or help you improve the fidelity and

    quality of implementation across schools. Partnering with our team will

    help you launch smoothly and with quality.

    For communities, local foundations, intermediaries, cities, states and local school districts, we can

    provide assessment services of existing conditions, help draft supportive policies and cultivate support for

    high performance schools.

    For Information Contact: Ted Fujimoto

    President [email protected]

    916-769-2417

  • Landmark Consulting Group BRIEF: Charter School Facilities Finance Strategy Update

    June 27, 2013

    Copyright 2013 All Rights Reserved. Landmark Consulting Group, Inc. www.ConsultLandmark.org 11 | P a g e

    Ted Fujimoto - Founder/President

    Ted Fujimoto is an experienced entrepreneur and consultant in organizational performance,

    development, scaling and business planning. He has helped develop business strategies for

    many education organizations including Bay Area Coalition for Essential Schools, Big Picture

    Learning, New Technology Foundation, Alliance for College-Ready Public Schools, Partnerships for

    Uplifting Communities, Linking Education & Economic Development, California Charter Schools

    Association and the New York Charter Schools Association - representing more than $150 million in

    funding. As a freshman in college, Ted founded and operated for eleven years a management and

    technology consulting company serving a range of customers including AirTouch Communications, Bank

    One, Chandon Estates, California Chamber of Commerce, GM, IBM, New York Times and Remy Martin.

    He was an equity partner in the consulting firm that developed the retail concept for Saturn Auto

    Company and re-engineered the retail networks of 11 automotive and hospitality brands.

    As a community business leader, Ted helped to design and found the highly regarded Napa New

    Technology High School and the New Technology Foundation which was acquired by KnowledgeWorks

    and as New Tech Network, is creating schools across the country. He also managed the Bill & Melinda

    Gates Foundation and Carnegie Foundation grants for education reform initiatives in the Sacramento

    region. He served on the California Education Technology Advisory Committee and received the 2002

    Center for Digital Government "In the Arena" award for education leadership in transforming vision to

    reality. In Converge Magazines, "1999 Year in Review," Ted was named one of "Educations Dreamers,

    Leaders and Innovators."

    He currently serves as Chairman of the Supervisory Committee at the California Credit Union, a $1.4

    billion credit union serving the education community. He co-founded and is on the board of the Right

    To Succeed Foundation and the Muzart World Foundation.