How investors make money from NYC Charter Schools despite purported ban on for-profit charters by Gavin Healy

The following post is by Gavin Healy, a public school parent and a newly-elected member of CEC2.  Though ostensibly, all new for-profit charter schools are banned from opening in NYC, there are still ways to make a buck off the proliferation of charters, especially as NY State law requires the city to reimburse charter schools for the cost of its leases at a very generous rate, one that it appears many charter schools including those whose management organizations own their own buildings have used to their advantage in many cases to inflate their own rent.  See the Class Size Matters 2019 and 2021 reports on this issue, and the letter from Senators John Liu, Robert Jackson and CM Rita Joseph asking the City Comptroller to audit these payments.  

Now that some charter schools are closing due to falling enrollment, such Harlem Hebrew Language Academy, they can sell off their buildings or rent them back to DOE,  and garner even higher profits, despite the fact that the city has already spent nearly nine million dollars on lease payments in the case of HHLA over the years.

Here Gavin reports on how Barone Management, which is in the process of building and managing a portfolio of 10 charter school buildings throughout the city, mostly in the Bronx, promises a steady rate of 22.5% internal rate of return (IRR) to its investors. What Barone explained below is that the per student amount set by the state and received from the city in rent doesn't align with the actual cost of the land, construction or maintenance; thus building charter schools in less expensive areas of the city like the Bronx guarantees a higher profit to investors. 

Thanks to Tanesha Grant, who first noticed this ad on Facebook.

Recently, I came across an ad seeking “investors” for the Bronx Charter School for Children, and immediately the question popped into my head: How can a NYC charter school have “investors” when for-profit charter schools are now prohibited under New York State law? 

Nationally, approximately 12% of charter schools are run by for-profit management companies. In New York State, charter schools had once been permitted to contract with for-profit operators, but the state legislature closed that loophole in 2010, and now only six for-profit charter schools remain in New York (four of them in NYC), grandfathered under the previous version of the law. Bronx Charter School for Children is not one of them.

So how can a “non-profit” NYC charter school be sold to investors? The answer to that question lies in what drives much of NYC politics: real estate.

The developer of this real estate project is a firm called Barone Management. Barone boasts of an “educational portfolio” of a dozen charter schools in NYC with close to 6,000 students, plus several more schools in development. For the Bronx Charter School for Children, Barone is renovating an existing building into a 28,000 square foot school. 

To partially finance the ground lease and renovation of the building, Barone is seeking investors through a “crowdfunding” platform called RealtyMogul, which hosted a webinar to answer questions about the project. RealtyMogul and Barone structured this project as a private placement of shares in a limited liability company established to lease the building to the (non-profit) charter school operator. As a private placement, shares can be sold to “accredited investors” (generally, people with a net worth of $1 million or more) without registration with the Securities and Exchange Commission. The Bronx Charter School for Children is Barone’s second “crowdfunded” charter school project in NYC, following one it completed for the Renaissance Charter School in Elmhurst, Queens in 2020.

In its webinar for potential investors, Barone offered a primer on the economics of what’s driving charter school demand in NYC. As Barone’s chief executive put it, “the NOI [net operating income] only grows as more students are enrolled.” Unlike payments under a more traditional commercial lease, which might be calculated on a simple dollars per square foot basis, total lease payments for this charter school depend on overall student enrollment. NYC is the only school district in the nation obligated to provide charter schools with rental subsidies, and this fact is a key element in Barone’s marketing pitch to investors. 

In the words of Barone Management CEO Scott Barone: 

“How does per pupil funding translate to real estate? Per New York City State and City charter regulations, 30% of an individual charter school’s per pupil funding is permitted to be spent on its real estate and facility needs. For the ‘23-24 school year, this equated to $5,502 per child per year. So, the short answer is that the more students you have enrolled in a particular school, the more robust its overall budget is, including its real estate budget, which is referred to as rental assistance in New York City.”

“Rental assistance” refers to payments NYC is required to make to charter schools established after 2014, or charter schools operating before that time that have since expanded, if such schools are located in buildings not owned by the NYC Department of Education. When the NYS legislature amended the charter law in 2014, it imposed the requirement to pay rental assistance only in respect of charter schools located in NYC and in no other school district in the state. As Barone notes, the amount NYC is required to pay to charter schools for rental assistance is $5,502 per student for the upcoming school year, a per student amount that has more than doubled since 2014. 

The Bronx Charter School for Children, established before the 2014 amendment, had not been able to take advantage of rental assistance until it expanded from a K-5 to a K-8 school starting from the 2020-2021 school year. The new location for the school will house these expanded middle school grades.

The amount of “rental assistance” due under the law is the “actual rental cost” of the charter school’s lease or 30% of per pupil funding, whichever is lower. In its pitch to investors, Barone is clearly setting the expectation that the amount of rent they will charge the charter school is the highest amount possible - 30% of per pupil funding - regardless of the actual rental cost. As the private placement memorandum provides, the base rent due under the charter school lease will initially be an amount equal to “(A) the greater of: (i) 30% of the Tenant School’s per pupil funding from New York State for the first Lease Year” and “(ii) $5,284.69; multiplied by (B) the Student Count.” 

The lease terms provide that the rent will increase by a minimum of 2.25% per year, plus a corresponding increase in that amount as student enrollment increases. Since “Student Count” is defined under the lease as the greater of the school’s actual enrollment and minimum enrollment numbers of 189 students in the first year, 200 students in the second, 213 students in the third, and 225 students in the fourth, the profits of Barone and its investors will rise as enrollment rises. The charter school also has a clear financial incentive to maintain its enrollment numbers, since if enrollment drops below those minimums, its rental payment obligations will not decrease. 

“Rental assistance” also explains why investors push for new charter school development in some neighborhoods rather than others. Responding to questions about crime and security around the school, Barone emphasized the presence of NYPD school safety officers, but ultimately turned the answer back to real estate economics, saying: “from a real estate perspective, for real estate dollars associated with a charter school, we get $5,500 per kid per year in rent. … I get that same $5,500 in the South Bronx that I would on Park Avenue. Obviously, the cost of my real estate is far cheaper in the South Bronx.”

Barone’s investment sales pitch is indicative of how charter schools can blur the line between the non-profit and for-profit education sectors. Barone’s chief financial officer projected total returns on a $100,000 investment in the school to be over $219,000 over the course of four years, and hinted at the potential for selling the project in its entirety to other investors at a later point. As an example, he cited how in 2019 “a large package of charter schools was sold … for over $450 million,” referring to the sale by a real estate investment trust of a portfolio of close to 50 facilities leased to a charter school operator. In that case, as with the Bronx Charter School for Children, it was buildings being sold rather than schools, but that distinction gets lost in the sales pitch to investors. In the real estate economics of the charter sector, schools are assets and greater student enrollment equates to a higher return on investment. NYC rental assistance guarantees these returns, and it also drives investor demand for charters in the South Bronx rather than on Park Avenue.