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Profit In Child's Play

Childcare centres are essential for working parents and buyer demand for properties is strong across the country, writes Sally Lindsay.

By: Sally Lindsay

1 April 2021

Early childhood education centres are a growth industry and a proven category for property investment.

“It would be a struggle to think of an alternate sector providing the returns and associated low risks for investors,” says Linda Harley, business broker at Childcare Sales.

The sector is viewed as more secure than other asset classes, because of not only the strength of the leases involved but also New Zealand’s high childcare participation rate.

Although early childhood education is an extensively regulated sector, and the entry barriers are high, New Zealand has more than 4,662 licensed services and about 2,750 of these operate as childcare centres. The latest statistics show more than 134,000 children are enrolled at childcare centres.

The majority of New Zealand’s childcare centres – more than 85% – are run by small independent operators, who might own one or two and be licensed for fewer than 50 places. Included in the ownership mix are about a dozen corporate operators.

Development of new facilities increased by 0.29% in the year to February. Over the years the market has grown from local centres of nine to 20 children serving a small area, to one that is increasingly dominated by larger purpose-built facilities designed to cater for bigger catchment areas and rolls of up to 70-80 and in some cases 100 children, says Bayleys business sales agent Prashant Vijan.

Many of the older centres tend to be a converted house. The modern facilities are purpose-designed and built and located in new commercial, light industrial and housing subdivisions. There is more activity in new builds than existing centres.

“Developers of new subdivisions want childcare operators as active tenants, says Vijan.
“The supply pipeline for this type of centre is strong.”

As the number of new centres swells, interest is growing rapidly and attracting a broad range of investors – from mums and dads who are considering making their first foray into commercial property to seasoned investors with a portfolio of similar properties.

Types Of Ownership

The variety of facilities means various ownership structures are available. They are being bought, sold and leased as businesses only, business and property going concerns or as investment properties only.

Harley, who has more than 13 years in the Australian and New Zealand childcare sales industry, says property investors can expect a return of 5.5-7.5% on the sale of a building, depending on the quality of the premises and the lease terms.

The sector has a mix of property ownership and business-only ownership.

“Some investors want to be the landlord only and there are more buyers than properties available,” says Harley.

If a childcare centre is sold as a freehold going concern with a split between the property and business ownership, Harley works to settle both sales simultaneously, particularly if an investor wants to be the landlord only.

“Often a prospective tenant takes the view they can fund the business operation but not the building and at a 25-30% return on the operation side, why would they want to put money into the building. It is a matter of getting the right match between the property and business owners and there are plenty of investors who want a passive property investment.”

Cost Of Centres

Prices for childcare properties range from $700,000 to $4 million, depending on the location and performance of the centre. Borrowing money for the purchase, says Harley, depends on the bank an investor is working with, the centre’s location and personal business plan.

“As a general guide, most banks will lend up to 40% of the purchase price for a leasehold childcare centre, and approximately 60% of the value on a freehold centre.”

Vijan has noticed the banks are requiring a lot more information to process loans and that is putting pressure on how quickly a deal can occur. Buyers are also being more cautious about buying a childcare centre at a premium. Childcare centres offer more security for a property investor than a traditional commercial tenant.

“An advantage for landlords is much of a tenant’s income is Education Ministry funding for 20 hours of free care weekly for children three to five years old at a childcare facility.”

Many investors are attracted to childcare centres as they tend to have longer leases than other types of commercial property, with 10 years and often further rights of renewal being typical, says Harley. She has a centre on her books with a 15-year lease and three five-year rights of renewal. Many leases offer annual rental growth at CPI, with market reviews throughout.

Most centres are single-tenant, hands-free investments, with the tenant managing all internal and external property-related issues.

A tenant is virtually locked in. A childcare centre resource consent is tied to a specific property and the business also needs a Ministry of Education licence to operate.

“A childcare centre tenant cannot easily move,” says Harley.

Rents for childcare centres vary quite significantly from area to area and can range from $42 a child to as high as $55 a child in high demand areas.

The Ministry of Education licence is the key component in any buying decision, says Vijan.

“If the licence caters for 40-70 children that is considered a reasonable size. Smaller centres have lesser demand as the cost of doing business can be higher.”

He says the success of a property investment depends on the quality of service the childcare centre provides; the geographical location; its financial and performance history – the longer the better; the demographics of the area; the accessibility of the centre – ease of getting in and out; and the concentration of centres in a particular location.

“Unfortunately, some areas have a high concentration of childcare centres.”

Early Childhood Council chief executive Peter Reynolds points to one three block area of Mt Eden that has 30 childcare centres.

“It is an extremely competitive sector, and some smaller centres are closing their doors as the cost of doing business is crippling them,” he says.

Do Your Research

Competition has a big impact. Some areas have too many centres and others an undersupply. Reynolds says the proliferation of childcare centres in some areas should be a thing of the past now the Ministry of Education is introducing new rules for obtaining an early childhood centre licence.

The ministry is now looking at demand and supply across the country. Until recently anybody could buy a site, build a centre and apply for a licence to operate it. The new rules mean a developer must now get ministry preapproval for a licence before applying for resource and building consent for a new centre.

Paul Rodgers managing director of Establish, a company specialising in planning early childhood learning centres, says developers will need to be better prepared than ever when considering the development of new centres.

For those wanting to build from scratch, the rewards can be greater than buying an existing going concern but the challenges are more substantial, particularly where land is scarce and prices are soaring.

Rodgers says developers need to establish whether there is capacity for a new centre within a community. This comes down to researching the existing population and future projections within a geographic area; demographics of this population; changes in land use and upcoming new areas of growth; type, location, size and occupancy level of existing facilities; and future childcare centres in the planning or construction phase.

He says data-driven decision-making will become a critical practice for property owners establishing new services or expanding existing centres.

Reynolds says there should be a better spread of centres under the new rules and not the high level, piecemeal expansion experienced in some of the country’s major cities.

Because, unfortunately, some areas have a high concentration of childcare centres, and in a competitive market it determines what fees parents will pay for a child at the centre. Better parent fees have a direct impact on the profitability and hence the landlord’s rent.

A Popular Choice

Despite the Covid-19 lockdowns and some niggling issues in the sector, property investors are still piling in to buy childcare properties. Particularly those that have the physical potential to grow the number of children under the operator’s licence by building on to an existing centre.

Many centres are on comparatively large sites with high underlying residential land values and with a drop in the number of carparks required at existing centres this can sometimes free up usable land for expansion.

Because of the burgeoning of interest in childcare centres, Harley’s business has already sold more properties so far this year than the whole of last year.

“Childcare assets offer attractive returns over the medium to long-term compared to other investments such as residential property,” she says

The sector is expected to remain strong providing investors with the opportunity to diversify into an asset class unaffected by offshore economic factors. Additionally, the internet will not make childcare centres redundant as they will remain an essential service, unlike some other industries.

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