The bricks and mortar of Childcare investment

There is a growing interest in property investment in the childcare sector – a sector that not too long ago was a fairly specialised and limited investment pool. This new interest in our Aussie long day care centres is attracting a broad mix of local private investors and private property syndicates. With regards to individual investors, we are seeing a modest increase in childcare acquisitions through self managed super funds (SMSFs). There has been a little hype within the industry about abnormally low yields (high prices) being paid by SMSF investors but the reality is that it’s just not that common. The majority of any institutional-based lending on childcare sites will be subject to a ‘panel approved’ child care specialist valuation, with valuations typically showing comparative market yields based on relevant sales evidence. In short, if you borrow it’s difficult to pay well above market value for a centre with this valuation process in place. This safe guard of panel approval is bringing comfort to new buyers who are unfamiliar with the industry, and, by reducing this risk, is helping the decision to purchase less daunting. More mum-and-dad passive investors are coming across from other industries such petrol stations, commercial office space and retail, and interestingly, they are also transitioning from residential investment to childcare. Why is this occurring? Quite simply, these investors are falling in love with the security of the sector, which is underpinned by government funding, corporate competition, higher yields and the year-in-year-out rental increases that many childcare leasehold investments offer. We find that there is some emotion attached to a purchase; buyers become aware of the social importance a facility which is engrained in the local community and provides at the very least -early education to our future generations. Childcare property investment is also powering on at the bigger end of town. Australian property trusts and investment funds have had a longstanding involvement with the sector; much of this involvement grew from the rise of ABC. The collapse of the giant didn’t deter, however, and funds like these continue to invest heavily in the sector and offer secure returns to their clients. When you are considering buying in this sector, as when you are considering any investment, you must do your research. Specifically in this sector, some key considerations when buying are: • The tenant Look at the quality of the tenant. Seek a site that has an experienced long-term operator (corporate, multi-site operator, individual) look for a long lease with options totalling not less than 15 years. Ask whether the centre has strong occupancy, whether the tenant is financially sound and capable of meeting ongoing lease commitments. Are there any outstanding issues between the tenant and landlord? • The building What is the age and presentation of the centre like? What condition is the building in? Will it require capital expenditure? And if so, will the amount be significant? Will the centre’s licence be affected by change in regulations and ratios? If so, will it impact the rent or the services profitability? Find out the replacement cost of the land and building; get a building and pest inspection done. Find out if there any outstanding requestions by the department? • Sustainability Assess the competition from other local centres, and the demographics of the area. Is it an ageing population or growing younger family catchment? Are there any childcare development applications (DA) in with council, what sort of fees does the centre attract? Assess the service location, visibility and user access; is it in close proximity to schools and business areas? Check the availability and cost of comparative land suitable for a childcare centre. • Yield What will be the return on investment? Find out the ‘true’ net yield; consider legal costs, stamp duty, GST, land tax, building insurance and other relevant fixed expenses. Generally, yields for childcare range from approximately the high seven per cent to the low nine per cent, with some rural remote or distressed centres attracting over 12 per cent – as a general rule the higher the yield the higher the risk. Yields should be carefully evaluated; every 0.25 per centre (quarter percent) can result in sizable price difference when selling or buying. • Lease – Work out the lease cost per child place (that is, $130,000 per annum (lease cost, divided by the number of child places, say 75 places = $1,733 per child place). Is the rent market, above or below? Are the yearly increases consumer priced indexed (CPI) or fixed? Are the annual increases noted across all options in the lease? Who pays for building maintenance and air conditioner servicing? When are the market rent reviews? Is there a ratchet clause (clause that stipulates that the rent can’t be less than the previous year), first right of refusal, etcetera. The value of a childcare business is heavily impacted by the length of remaining tenure. Quality operators should seek additional options to ensure that their business value isn’t diminished. Operators generally like to see 20 years or more reaming, and it’s not uncommon to see new lease negotiations with 30 years or more. And as with any investment, the utmost attention must be given to your strategy with finance. Lenders can lend up to a maximum of 70 per cent loan value ratio (LVR) against a child care centre (CCC) freehold passive investment. They can also lend to a maximum of 70 per cent LVR for a freehold going concern (that is when an operator of a CCC also owns the freehold, the lender can lend to 70 per cent LVR against the freehold and going concern valuation). If an operator is seeking finance for a leasehold business, lenders will generally fund a maximum of 50 per cent LVR of the leasehold value. The loan term in this case will also be determined by the terms of the lease, and lenders will require a right of entry (ROE) and mortgage over the lease. In either case, to obtain maximum lending exposure, clients will need to meet the lender’s benchmarks for debt service or cover ratio (DSR) and interest cover ratio (ICR). Each lender has different requirements and benchmarks, but as a general rule they require 1.5 times DSR (that is income is 1.5 times that of the debts that are required to be met), and 2 times ICR (that is, income is two times interest liability). Each lender that is in the child care (CC) space has slightly different policies and I would always recommend every client work with their finance broker/bank, accountant and solicitor conjunctively before making decisions that could become costly down the track. There are cost, taxation, finance structuring and other issues to consider. Each of the professionals highlighted will give advice from very different perspectives – the solicitor will consider asset protection, the accountant will consider taxation advantages and possibly asset protection, that broker and lender will consider ease of transaction, structuring and cost minimisation etcetera. When all three of these professionals work together, generally we’ll end up with a far better outcome for the client. Regardless of whether you are buying or selling, be sure to seek advice from professionals who specialise in the childcare industry. By dealing with solicitors, accountants, valuers, industry-specific lenders and reputable childcare brokers, you will save considerable time and money. Most importantly you will be proactively minimising the risk associated with a specialised transaction. For recommendations for any specialist professional services, or further details regarding buying or selling childcare, contact Lincoln Bridge through the Benchmark Childcare office.