Develop or buy? The key childcare question

A Chatswood childcare centre sold on a record 3.9% yield.
A Chatswood childcare centre sold on a record 3.9% yield.

Childcare is all the rage when it comes to commercial property, with investor interest at peak levels and yields at historic lows.

But what about those wanting to build from scratch? Are the returns for developers wanting a slice of the action as good as those being achieved by investors?

Colliers International’s white paper Child Care: Australia’s Burgeoning Real Estate Investment Class, suggests it is a challenge for childcare centre developers, and particularly smaller, private entrants, to build a viable enterprise in an increasingly competitive marketplace.

Grip tightens: Major players set to dominate childcare property market

The report says that while larger developers have been “reluctant to take on development risk” in recent years, instead focusing on acquiring privately-owned centres, they still hold distinct advantages over smaller builders.

Among the key considerations outlined in the white paper:

Land availability

Colliers’ report says a lack of available inner city and metropolitan land has seen growth in the number of new centres slow from 6% year on year between 2004 and 2007, to just 3%.

“(This) will continue to slow as listed organisations target suitable development sites, and also compete for these sites with residential, commercial and aged care developers,” the report says.

“The issue with inner city and metropolitan areas is the lack of space needed to adhere to national government guidelines of 3.25sqm of indoor and 7sqm of outdoor space per child, both of which are to be strictly unencumbered. This requirement arguably places the most restraint on growth within inner city precincts.”

A Camberwell childcare facility sold to a Chinese investor for $6.82 million.

Land is becoming increasingly difficult to procure for childcare developments.

But the news is better in regional areas, where vacant land is more abundant, although childcare place vacancies are also higher.

“As such, we think that over the longer term, growth will occur in outer regional areas, albeit limited, while inner city developments have been forced to become more innovative, creating opportunities for child care centres within mixed use developments in order to keep up with growing demand,” the report says.

Historic lows: Record yields as investors flock to childcare centres

“Regional areas face an oversupply of centres, which operate at an average occupancy of 50% to 70% due to attendance fluctuations in communities with low population or that are reliant on seasonal trade, such as farming.”

The cost of building

Constructing childcare centres, which average 1000sqm to 3000sqm of indoor and outdoor space and thus require considerable amounts of land, isn’t cheap.

Colliers International’s report says that while childcare can be a lucrative endeavour, startup costs can seem imposing, which puts institutional developers and buyers in a position of strength.

“Substantial setup costs such as site purchase, development, facilities and equipment costs can be prohibitive,” the report says.

Guardian is set to open a new childcare centre in Richmond. Picture: Guardian.

Childcare centres aren’t cheap to build.

“Educational programs and the cost of staff as well as minimum educator-to-child ratios also creates cost inflation, especially in an industry where wages are the largest expense. This could discourage new smaller, private participants in a market where institutions have the funding and ability to easily attract staff, meet regulations and implement a variety of educational programs.”

“(Childcare giant) G8’s strategy of quality over quantity might see other institutions adopt a similar plan as the bar for childcare services continues to be raised.

Red tape

New childcare market entrants need to be prepared to jump through a few hoops in order to get a centre up and running, according to the report.

Private operators and owners could also be pushed out of the market as the cost and time to obtain approvals and licenses place a significant strain on new business development, even though up to this point, they have served the industry as feeder businesses,” it says.

The payoff

While the barriers to developing a childcare centre can seem challenging, the return on investment can be significant.

Colliers’ Associate Director of Transaction Services – Childcare, Brian McInally, says centres usually sell for between $1.5 million and $6 million, with prices soaring in recent months and yields averaging between 5.5% and 7%.

One centre in Chatswood sold for a record low 3.9% yield earlier this year.

Retaining ownership of them can also be a safe and secure investment, with most centres enjoying long-term leases.

“Initial lease terms are between 10 and 15 years with options of five, 10, and 15 years, respectively,” McNally says.

“More recently, however, 20-year options are being agreed to.”