The Local Initiatives Support Corporation (LISC) surveyed charter school developers to collect information about the development services/models they offer and how they structure their development deals. Seven developers representing both for-profit companies and nonprofit organizations responded and spoke with LISC about their models. Below, we distill the findings from that survey as well as LISC’s experience working with schools on a wide range of facilities projects, with the goal of helping school leaders understand what typical models look like and become more efficient and informed consumers as they explore various development approaches.
Development Services Offered
- Most charter school developers offer a range of development services, from relatively discrete contract services like site selection to owner’s-representative services all the way to full turnkey development. Some developers (typically for-profit developers) work with schools only in a developer/landlord capacity in which they use their own capital to develop the project and lease it to you, sometimes with a purchase option.
- Developers acting in a developer/landlord capacity will typically cover the upfront predevelopment costs for your project and recoup those costs through your lease payments. These upfront expenses may include putting down a deposit to secure a site, which can be a significant cash outlay.
- Covering predevelopment expenses is potentially a differentiating factor between a fee developer model and a developer/landlord model and is something you should ask potential development partners about.
- Developers typically require you to sign a predevelopment agreement in which you agree to reimburse them if the project does not move forward, and some require a deposit. This is a legal document and should be reviewed by an attorney.
- Developers charge a fee, typically 3-5% of project costs and sometimes higher, to develop your project. In a fee developer model, this fee is the payment for their services and can be considered their “return.” In a developer/landlord scenario, this fee may be blended in with the developer’s overall return.
- Best practice is for the development fee to be paid over time either throughout the construction period (in a fee developer arrangement) or through lease payments, so that the developer is on the hook (i.e., has a significant portion of its fee at risk) through project completion.
Developer/Landlord Model Considerations
- LISC received a range of responses as to how developers establish rent, including:
- A percent of total project costs (range: 8-12%).
- A percent of school’s per-pupil revenue (range: 10-20%; developer-specific averages of 12%, 13%, 15%, and 17%). An important consideration here is whether rent is adjusted for enrollment, which it should be for schools that are ramping up to full enrollment during the first few years of the lease.
- A multiple of the developer’s debt service on debt incurred for your project (range: 1.15x-1.25x).
- Many developers will look at rent from multiple angles to make sure they’re covering their costs and earning their return without placing an unsustainable (>18-20% of total public revenue) lease burden on the school. You should too. Paramount from the school’s perspective is that rent not exceed 12-15% of your per-pupil revenue, ideally adjusted for enrollment (your “facilities burden”). It’s common for schools to pay a higher percentage (i.e. 20%) of per-pupil revenue while they’re ramping up enrollment, but your target should be to spend no more than 12-15% of per-pupil revenue on lease payments at full enrollment. (These percentages assume a triple-net lease structure, where the school is responsible for paying applicable real estate taxes, maintenance, and insurance, in addition to rent and ordinary facilities-related costs such as utilities and janitorial services.)
- Annual rent escalators typically range from 1% to 3% (aside from rent that grows in proportion to enrollment). It’s important to look at those escalators in the context of historical and expected trends in your per-pupil funding rate. For example, if per-pupil revenue increases have historically averaged 1% per year, you will quickly run into problems with a 3% rent escalator (that is, your facilities burden will go above 20% within a few years). Model out the rent payments as a percentage of conservatively projected per-pupil revenue to understand how the lease will impact your budget and your facilities burden over time. Look out for more aggressive rent escalators that may kick in if you do not purchase your building from the developer by a certain date.
- The price and timing of a purchase option within your lease is a critical consideration as you evaluate and compare development strategies. You should query potential development partners (and eventually, carefully review the lease) to determine if there is a desired or required timeframe for you to purchase your building. In most cases, either the purchase-option price or the rent (or both) will escalate, sometimes aggressively, beyond that desired window for you to buy the building. (The exception is when you and your developer/landlord have a mutual intent to remain in the lease long-term.)
- Among developers we surveyed, the intended window for schools to buy their buildings ranged from one to seven years from occupancy, with four to five years being the most common response. Pay close attention to both escalators and other penalties in your lease that are triggered if you do not buy your building within a certain window.
- According to survey responses, the purchase-option price and method of escalating the price (if applicable) is highly project-specific but typically calculated based on:
- Total project costs, fixed throughout the term of lease (not a multiple of total project costs—there is no price escalation). This is a common approach among nonprofit developers.
- A multiple of total project costs (range: 103-115% of total project costs).
- Total project costs with an annual escalator that kicks in after a certain year, as early as Year 1 or more commonly after Year 3, 5, or 7 (range: 2.5-5% annually, which could mean you’re paying over 125% of project costs by Year 5).
- Some developers (predominantly nonprofit developers) will offer the school a credit towards the purchase-option price in certain circumstances. This is something you may be able to negotiate. Some examples we’ve seen, all of which are worth asking about, include:
- Credit for rent paid in excess of the developer’s debt service for your project (i.e., if the developer has been collecting rent at a rate of 1.15x their debt service, you may be able to negotiate for some of that excess to be credited to you when you purchase the building).
- Credit for the amount of principal amortized on the developer’s debt from your lease payments.
- Credit for any subsidy program the developer may have used to finance your project. The most common example of this is developers giving schools credit for New Markets Tax Credit equity when the school purchases the building at the end of the seven-year NMTC compliance period.
Written by: Sara Sorbello, LISC
Special thank you to: Jennifer Afdahl-Rice, PCSD
Nothing in this material should be construed as investment, financial, brokerage, or legal advice. Moreover, the facts and circumstances relating to your particular project may result in material changes in the processes, outcomes, and expenses described herein. Consult with your own professional advisors, including your financial advisors, accountants, and attorneys, before attempting to consummate any transaction described in this material.