Virtus inks debut early-education RE deal – Exclusive

The alternatives-focused firm is working with a Morgan Stanley-owned operator on a 21-asset portfolio.

Charleston, South Carolina: one of Virtus’s new properties

Investment firm Virtus Real Estate Capital has agreed to its first early-education real estate deal, PERE has learned.

In a joint venture with an education-focused developer, the Austin-based firm acquired a 21-property portfolio for about $58 million. The properties, located in Colorado and North and South Carolina, serve children from three months old to pre-kindergarten and are run by Morgan Stanley-owned Cadence Education, which owns 170 schools.

Charter Stone Capital, a private firm that specializes in education-based real estate, sourced the deal and took a minority stake in the portfolio, said Kevin White, Virtus’s head of acquisitions. Virtus has worked with the firm previously on charter school investments.

Virtus’s capital for its majority interest came from its latest opportunity fund, Virtus Real Estate Capital II, which closed in July 2017 on $309 million, PERE previously reported.

White said the early-education space is so fragmented that even the total number of properties is not known. Most new properties are “institutional quality” spaces ranging from 10,000-12,000 square feet, he said. The submarkets in which Virtus now operates also have double the under-five-years-old population compared to the national average, leading to strong demand for early-education spaces. 

“The majority of the real estate in this industry is still owned by local developers and real estate owners,” he said. “The fragmentation is part of the opportunity and what makes this space attractive.”

For this portfolio, the new owners extended the properties’ leases – most of which had seven-year terms – to 17 years. With the CMBS loan for the portfolio due in six years, Virtus and Charter wanted to avoid having most of the leases expire a year later, White said.
Kevin White: Virtus’s head of acquisitions

“When we put the deal under contract, it was with the thought that if we come to the table, we could structure a mutually-beneficial lease extension where we get more term on the leases and give the operator some concessions,” White said.

He added that Virtus was “confident” Cadence would renew the leases ahead of their original end dates, based on strong demographics in the portfolio’s markets. White cited both the local growth rates for children under five years old and the number of working mothers as demand drivers for early childhood education.

While he predicts multiple exit opportunities from this portfolio, he said the most likely buyer is a triple-net-lease investor seeking cashflow-driven investments.

“Today, yield is extremely expensive,” White said. “To have a large-scale portfolio that generates a high amount of cash-on-cash we think is a very attractive opportunity for somebody. Our play was, going into it, we wanted to get the leases restructured, and that was a big value-add.”

White added that the firm wants to hold the CMBS loan until it’s not cost-prohibitive to pay it off – potentially for five years until it matures – then sell the portfolio. “While there’s not as much upside, there’s less unknown in this transaction,” he said.

Virtus, which is now Cadence’s second-largest landlord, plans to work with the company in the future as it streamlines its landlord relationships. Virtus could acquire some of Cadence’s existing properties and help with its future acquisitions, most of which are sold by mom-and-pop enterprises.

“They’re in the education business, not in the real estate business,” White said.