Investment

Bricks of debt

Securing the funding for a school purchase can be a fraught process. The lender will want to see evidence of research along with strategic plans for the future business. David Yeadon runs through the options

So you have found a school you would like to buy? The hard work starts here, as you must now assess the viability of the business. If you are investing in a school as a going concern, you need to be assured of its financial stability. There should also be an evaluation of the quality of management, areas with potential for further development and any weaknesses that need to be addressed. What is its financial position, general management and overall potential? Lenders will look at the quality of the loan applicant: your own school should provide evidence of an effectively managed enterprise.

An analysis of the potential business is crucial. For more information on this, refer to articles by Robert Boyd (pages 6-7) and Steve Chinn (pages 22-23) in the April 2007 issue of Funding for Independent Schools.

Freehold versus leasehold
One of the difficulties when purchasing an independent school is that a large number are owned on a leasehold rather than a freehold basis, which can make it difficult – although not necessarily impossible – to secure funding.

The level of funding will depend on whether the property is freehold or leasehold. If it is leasehold, how long the lease has left to run is of paramount importance.

The problem with a lease is that it is a depreciating asset: less than 30 years and a provider will review whether it is prepared to lend. If the school has a long lease – more than 35 years – with low rent, the lender may be prepared to treat it as it would a freehold acquisition.

How much can you borrow?
If the school is freehold, you should be able to borrow senior debt up to 75 per cent of the going concern or business value. This leaves a large deposit to raise, but it may be possible to borrow a further 5-10 per cent of the purchase price in mezzanine lending, depending on the proposition. This part of the debt would need to be amortised quickly to bring the loan down to 75 per cent – certainly within three to five years. The 75 per cent funding on the freehold could be taken over a much longer period of, say, 20-25 years.

It may be possible to secure the senior debt on an interest-only basis, but most lenders would prefer the mezzanine debt to be repaid at the earliest opportunity.

What it costs
Rising interest rates have forced mortgage rates up, whether residential or commercial. On the senior debt, this is usually offered between 1-1.75 per cent above bank base rate (which was 5.75 per cent as this publication went to press), giving a pay rate of 6.75-7.50 per cent. The mezzanine debt will be more expensive: 4-6 per cent above base rate, giving a pay rate of 9.75 to 11.75 per cent, which is an incentive to clear it quickly.

While assessing the viability of the purchase, it is important to consider what will happen if rates rise further and whether you could afford the increased debt repayments. The market expects at least one more quarter-point rise in the near future. Of course, you will also benefit if rates start to fall. To calculate the servicing ability, the minimum surplus of funds after loan repayments should be 1.5 times.

Given the climate of rising rates, you could safeguard your funding position by securing 50 per cent of the debt on a hedged basis. The rate will depend on prevailing Swap rates – the cost to the lender of borrowing funds in the money markets – on the day that the money is secured.

While you could borrow the bare minimum in order to keep costs down, it is important that you are not underfunded.

You should have sufficient money available for:

• purchase price;

• stock;

• stamp duty: 4 per cent on property purchases above £500,000;

• professional costs to include solicitors and valuation; and

• arrangement fees.

A final consideration is the size of the working capital you will need; this depends on the size of your acquisition.

David Yeadon is a director and head of the commercial debt division of Savills Private Finance. David can be contacted on 020 7409 9991 or dyeadon@spf.co.uk

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