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Inside EPR’s Charter School Investment Play

Inside EPR’s Charter School Investment Play

Entertainment Properties Trust (NYSE:EPR) is a specialty REIT that boasts an investment portfolio worth roughly $2.9 billion comprised of megaplex theaters, urban ski resorts and charter schools.

In the last area, the Kansas City, Mo.-based REIT has found itself a niche, with no other REITs investing in the charter school space. (On the private side, former tennis great Andre Agassi has teamed up with Canyon Capital Realty Advisors LLC to form the Canyon-Agassi Charter School Fund. That venture recently completed its first charter school development project in Philadelphia.

Entertainment Properties Trust counts 34 charter schools in its portfolio. This asset class, which accounts for 11 percent of the company’s overall portfolio on an asset value basis, achieved a 7.2 percent dividend yield in 2011.

REIT Insider connected with David Brain, who has served as president and CEO of Entertainment Properties Trust for 11 years, to discuss how the REIT’s charter school investments work.

REIT Insider: Why do you find charter schools an attractive investment?

Brain: We are a specialty investor, and we invest in specialized assets that require specialized and unique expertise to understand. We like charter schools because they meet our “5 Star Investment Criteria” strategy, which screens investments for us and identifies where we are going to spend our resources. We look for new generation properties within a very long-lived and durable category. Charter schools, for example, are a new generation of public schools.

REIT Insider: What is the overall demand for charter school across the nation, and is that demand sustainable?

Brain: A lot of people don’t understand that charter schools are public schools—students attend free of cost. Charter schools are independent of a school district, operating under a direct contractual arrangement with the state, which has an obligation to pay for charter school operations.

There are 41 states plus Washington D.C. that have charter school legislation on their books. They account for about five percent of total enrollment nationally, and enrollment is growing at 10 to 12 percent per year. In some cities, charter schools are more material. In Kansas City, Mo., for example, charter schools account for 30 percent of public school enrollment. And, in post-Katrina New Orleans, the city operates without a centralized school district, and 90 percent of children attend charter schools.

Parents see charters schools as a hybrid between public and private schools. These schools are so popular there are lotteries to get into them. There are 400,000 kids on waiting lists to get into charter schools. The facilities market opportunity is estimated at $7 billion.

Choice is what drives interest in charter schools. They are the result of parental dissatisfaction with local school districts. The dissatisfaction comes from a number of sources: bureaucracy, lack of appropriate education and lack of specialization [language, arts, etc.] By their nature, charter schools are more responsive to parents, and they spend more of their total budget on in-class activity and less on administration.

REIT Insider: But charter schools have their opponents as well. Is that a concern at all?

Brain: There will always be opposition when challenging the status quo. With the current administration’s focus on improving American education, the value and performance of charter schools has been publicly debated. However, I think you’ll find that the supporters of charter schools greatly outweigh opponents, as illustrated by the bipartisan support public charter schools have received.

REIT Insider: How is this segment performing in comparison to EPR’s other investments?

Brain: We’ve been investing in charter schools for more than four years, and our results have been very positive. They’re performing well; we’ve never had a default, and the yield is consistent with the rest of our investments.

REIT Insider: How does EPR structure deals with charter schools?

Brain: We view our investments as a partnership with the operators, as well as the parents and students. We invest in charter schools in two ways. One, there are charter schools in place that have been operating for a few years, but started under very challenging circumstances. Now that they’ve developed a stable enrollment, we’re able to come in and build a new facility so they can grow.

Second, there are offices within each state government that govern charter schools called charter authorizers. These offices are involved in the very early stages of a charter school, and they often refer new charter schools to us so we can supply a quality facility to them.

In both cases, we usually build or rehab existing schools, or even non-school buildings. We execute a long-term lease of 20 to 25 years. The leases are backed by the charter holder or the charter school management company. Our average investment is $7 million to $9 million.

Though we don’t have a direct relationship with the state, often the monthly state reimbursements will come directly to us. It’s a very sophisticated arrangement.

REIT Insider: With what types of organizations do you prefer to partner?

Brain: We like multi-site operators with both a proven track record and proven curriculum. Our preference is to work with multi-site operators rather than single-site, one-off operators. We like organizations that have visibility of enrollment—they can demonstrate enrollment history and have specific waiting lists.

We also prefer jurisdictions [states] that are friendly toward charter schools and those that provide good reimbursement levels. Florida and Arizona are good examples of the jurisdictions we like.

We also like areas where the school district’s facilities are inferior. If by chance charter legislation was overturned in a particular state, our tenant might change, but if we have built a good facility in a district where other facilities are in poor shape, we would be able to sell or lease back our facility to the school district… so the real estate matters, along with the operator.

REIT Insider: How does the current state and local funding environment impact charter schools?

Brain: Public education is largely a state-supported activity—about two-thirds of education funding comes from states and the remainder is a mix of local and federal. While there are some budgetary pressures on the state level, the key thing to understand is that education is one of the last items to be cut from the budget, and even then, you have to make the distinction between cuts for higher education and elementary education.

Because elementary education is considered a core responsibility, and higher education is considered a privilege, states are more likely to cut higher education. In Missouri, for example, the state just announced double digit cuts to education. But when you delve into it, the cuts breakdown to 12 percent in higher education, and only 1.5 percent at the elementary level.

There’s also the misconception that charter school funding will be cut because it will save the state money. By statute, states cannot cut funding to charter schools, and even if they could, they don’t save any money by doing so—the kids will still be in the public school system.

REIT Insider: What are the key takeaways investors need to know about this space and EPR’s efforts in this area?

Brain: Our primary competition is not another investor, but rather the debt market, specifically a charter school’s access to debt. We don’t see any other REITs operating in this sector. Most people don’t take the time to understand it, although it is very large category representing more than a trillion dollars.

Right now it’s tough for charter schools to access debt, although some can finance their projects with tax-exempt bonds. But there are issues with that structure too—it’s unreliable in execution.

We think we have an advantage because we can be more flexible than other financing options like bond offerings. For example, we borrow at the corporate level and not the asset level.

We think the market opportunity here is very large, and we expect to do quite a bit more business in this sector.

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