The Tax Cuts and Jobs Act of 2017 created Opportunity Zones (“OZ”), which provide tax incentives for investment in designated census tracts. Since then, there has been a lot of buzz about the potential for Opportunity Zone investments to accelerate the charter school movement across the country. There are 8,700 Opportunity Zones –and while many have charter schools, approximately 70 percent of them are charter school deserts, according to Education Next. This year saw the very first OZ-funded project that included a charter school come to market. Zeta Charter School (Zeta) plans to open its South Bronx campus for the 2020-2021 school year in a multi-use development, conceived and led by New York developer AB Capstone and financed by Starwood Capital’s new OZ investment program. Zeta’s General Counsel, Jessie Ferguson, explains that educating the investor community about financial and operating risks of the charter school industry was key to getting the deal done. With the potential for charter school growth in OZs, educating additional OZ investors could spur more enthusiasm for investing in and including charter schools in OZ development.

Educating the OZ Investor Community

Even a quarter century into the movement, charter schools are still largely misunderstood. Capital providers such as commercial banks and bond market investors have taken to the industry relatively cautiously, often raising concerns about the associated risk of charter renewal periods that occur within a financing term. That said, the historical default rate of charter schools is worthy of envy. While nearly 50 percent of all start-up businesses do not make it to a fourth year of operation, the majority charter schools do. In fact, most charter schools in existence today have received at least one charter renewal, providing strong evidence that their operations have stabilized. Ferguson pointedly asked, “Which would you rather have as an anchor tenant – a start-up restaurant or a charter school?”

A social-minded developer looking for a strong anchor tenant and a motivated OZ investor were key to making the project work for Zeta. “There were no guidelines or regulations out on Opportunity Zones yet when we first identified that the site was located in an Opportunity Zone,” says Ferguson. Nevertheless, the team blazed a trail through early development and lease negotiations with the OZ funding top of mind. While the school was not privy to detailed terms of the OZ investment, Ferguson is convinced that an affordable lease would not have been possible without it.

The mixed-use approach to the South Bronx project also helped assuage underwriting risk concerns for the investor. The community and amenities within the project will be beneficial to the school too: potential tenants include restaurants and coffee shops that will cater to teachers, parents and families, as well as a nonprofit organization aligned with Zeta’s mission. Another multi-family housing development will go up across the street from the school’s campus as well. There is no doubt that the presence of a quality school will serve a critical role in the long-term economic and social health of the community.

Growing Enthusiasm for an OZ Impact on Charter School Growth

Ron Beit sees a lot of room for OZ fund investors to help solve the facilities challenge for charter schools. Beit, CEO of RBH Group, recently completed Teachers Village, a $150 million mixed-use development project in downtown Newark, NJ, that is home to three charter schools, 203 units of affordable housing for teachers, 18 retail stores and an early childhood center. His charter school development experience predates Teachers Village. His first school development was KIPP Academy in Newark, completed in 2009. Now RBH Group has another eight Teachers Village-type projects in major metro areas planned across the country over the next 12-24 months.

Mr. Beit’s original vision with these projects was to provide affordable workforce housing to teachers along with educational offerings to create a unique community and high quality of life. The premise was that with such a community, teachers would be the “first movers in the emerging markets of neglected urban areas.” His firm began assembling parcels of property in 2005 and had several projects in the pipeline in what ultimately became “Opportunity Zones” by the time the Tax Cuts and Jobs Act of 2017 was passed. As Beit says, “Teachers Village was born in what was the predecessor of Opportunity Zones.” Although this pipeline of projects would have been financeable prior to the Act, the serendipitous timing of the new legislation will create, by definition, long-term equity sources from a cohort of investors that prior to the Act would not have spent the time to understand the complexity of these projects. He calls the incentive for investors to take the time to understand projects in many areas that would otherwise have been ignored, “one of the greatest benefits of the Opportunity Zones”.

Thus far, OZ fund investors are focusing almost entirely on tier one projects in tier one markets – projects that would have otherwise been financed through conventional sources. But Beit expects that to change in time. The projects currently under finance were already underway within an OZ, but once they are exhausted he says that, “There will be many years of Opportunity Zone financing and charter schools are a natural fit for Opportunity Zone fund investors.” The fundamental economic nature of primary and secondary education and the 10+ year investment horizon of OZ fund investors are what make the pairing especially attractive. And, over time, more equity capital seeking a limited number of projects in these focused geographic areas should put downward pressure on the cost of this capital further facilitating the construction of schools.

What’s Next?

Of course, how and when OZ fund investors turn their attention to single-use charter school projects is a question that remains to be answered. Perhaps one of the more important factors will be informing investors of a charter school project. The first step may be the creation of a ‘marketplace’ for these investors to easily find viable charter school development projects. School leaders can reasonably determine whether a site is located in an OZ through an interactive map hosted by The Opportunity Exchange website (www.the opportunityexchange.com). The Exchange also provides investors and charter schools with opportunities to identify potential projects and provides a listing of projects in certain cities.

The second step will be for leaders in the charter school movement to educate the OZ investor community about the relative safety and soundness of investing in charter schools. The leadership team at Zeta learned first-hand that the school has a role in attracting and educating investors. Simultaneously, charter school leaders will need to learn more about potential OZs can have to positively impact school financing. Just because an investment qualifies for OZ tax incentives, does not mean it is the best option for the school. There are many details to understand in advance, including the refinancing of the OZ investments 10 years from now. There is a need to develop resources that accurately assess the pros and cons of OZ fund investor financed facilities in contrast to other facility alternatives.

Check out our webinar for more information on Opportunity Zones.