[+] Growing Fast: Why Investors Love Childcare

Despite their chequered past, childcare centres have become some of the most desirable real estate assets for investors—and the sector has become even more attractive after a $1.7-billion boost in the federal budget.

In fact, the government’s generous support of the sector coupled with attractive long-term leases, have contributed to making childcare assets increasingly sought-after.

But the trick with this sector is balancing investor returns and day-to-day cash flow management with quality care for children.

It was a balance ABC Learning was unable to achieve.

The national childcare centre chain was widely revered by investors and held up as an example for others to follow, until it spectacularly collapsed under a pile of debt during the GFC.

Its assets are now mainly owned by one of the major players in the sector, Goodstart. Investors have subsequently been wary of the sector. Until now.

Childcare is an $11.6-billion industry in Australia.

Today, childcare centres are fairly well-accepted commercial real estate investments due to long-term leases, good support from the government and the many well-established operators.

The major players are Goodstart, G8 Education, C & K, Affinity Education, KU Children’s Services and Guardian Early Learning.

According to figures provided by Damian Delahunty, chief executive of developers Viable, these operators account for more than 17 per cent of the market.

“Childcare is a privatised sector and so the asset class ranges from independent individuals and small families to large corporations,” Expeditions Early Learning director Yunis Omar said.

“The two major players are Goodstart Early Learning and the G8 group as they own the largest number of centres.

“The rest, which is the majority, are privately owned.”

▲ Goodstart’s purpose built, state-of-the-art facilities cater for children from six weeks to five years, and include a high-quality pre-school program.
▲ Goodstart’s purpose built, state-of-the-art facilities cater for children from six weeks to five years, and include a high-quality pre-school program.

Ryan Banting is Australian Unity’s general manager of social infrastructure.

He said statistics showed an additional 3000 childcare centres were needed during the next 10 years to cope with increased demand as more women looked to rejoin or enter the workforce.

“Childcare assets are generally specialised in design, as centres require registration and ongoing assessment against standards that are constantly being updated,” he said.

“Design is often influenced by operational and equipment considerations specific to each centre and operator.”

For instance, some early learning centres have programs that require specialised designs to accommodate facilities such as kitchens and language rooms.

Others must be designed to include special outdoor areas such as room for chicken coops.

Returns and yields

The sector experienced strong yield compression late last year as a result of government support through the challenging Covid-19 lockdowns.

Yields from child care assets have firmed further since additional funding for the sector was announced as part of this year’s federal budget.

“There is evidence of assets trading at cap rates below five per cent at auction, but buyers are usually private investors,” Banting said.

“More often than not, they are unable to commit to a capital partnership to develop a pipeline of assets.

“We are starting to see some portfolios being offered at cap rates of 5 per cent that would have been 5.5 per cent six months ago, so this is a big shift in the sector.

“That said, we believe the market for institutional-grade product is in the 5.25 per cent to 5.5 per cent range, and slightly higher in regional centres.”

Leases tend to be standardised. Most initial lease terms are for between 15 and 30 years, depending on the agreement with operators.

“Childcare centre leases are some of the longest in the real estate sector, often with a number of subsequent option terms,” Banting said.

In addition, most leases are “triple net” in structure, where all outgoings and capital expenditure are borne by the operator, who is the lessee, with the asset owner maintaining the asset. Government aid supports occupancy rates and rents.

▲ Childcare operators did not raise fees last year as the government provided assistance packages to the pandemic-affected sector.
▲ Childcare operators did not raise fees last year as the government provided assistance packages to the pandemic-affected sector.

“Like other sectors, success relies on developing strong operational partnerships with high quality, in-demand operators,” Banting said.

“Completing detailed due diligence on specific locations is of the utmost importance as sometimes different streets in a catchment area mean the difference between a successful centre and a not-so-successful centre.”

Leases are generally calculated based on the number of permitted childcare spaces and the normal range is between $2000 to $5000 per child.

“They do go as high as $6000 per space in some instances,” Delahunty said.

The base is a 30-year lease, with a market review every 10 years, Omar said.

“The rent is determined as a payment per child for the whole year.”

For instance, a centre with 70 children that pays $3000 per child would pay $210,000 in rent each year.

Leases generally increase by CPI or by fixed rent-reviews, so the rental income is a great hedge against inflation, and leads to the sector’s reputation of offering strong, stable income and the opportunity to participate in capital growth through time.

On an investor level Banting said returns depended on the fund manager’s ability to add value through a well-managed and diversified fund, with development-funded assets aligned to strong operator agreements.

“We are aiming to deliver circa 10 per cent internal rates of return in the childcare sector with no returns of capital to support initial distribution yields,” he said.

Local and global investors are interested in the sector as it is private, yet government subsidised.

Developer and operator landscape

Banting said development yields ranged from 5.75 per cent to 6.25 per cent.

“We believe it is important to monitor supply risk in certain areas, which is why due diligence and industry expertise is so valuable.”

Delahunty said real estate investors looking for long-term, stable returns were always interested in childcare assets.

“Developers also often purchase properties with a view to rezoning and obtaining permits for future centres,” he said.

“But this practice may be impacted by the newly-announced windfall tax on developments that have been purchased to resell.”

The Victorian government has announced a highly unpopular proposal to tax landholders whose property values rise when their land is rezoned.

Like all commercial assets, Delahunty said the location and operator preferences impacted construction costs.

“These factors will also have a bearing on the potential income achievable by the operator, which will impact the centre’s value and lease income potential,” he said.

Above all, he said, developers should work with operators during construction, as every childcare brand has different values and a particular build that works with the activities and commodities they provided.

Overall, childcare has emerged as an attractive asset class. But investors and developers should remember subsidies are at the discretion of governments—what may seem like an attractive asset now can lose its lustre down the track.

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Article originally posted at: https://www.theurbandeveloper.com/articles/why-investors-love-childcare