Today I want to talk about a sector that many developers often overlook, childcare centres.
Many developers complete childcare center developments as a pure property play. They negotiate a 15 year lease with an established operator, complete the construction, and then either sell the property for a profit or hold onto it as a high quality long-term investment.
But over the years, we’ve seen a fair number of these developers realise that there’s actually more money in the childcare business itself rather than the property. A well-run childcare business with occupancy north of 85% can be one of the best returning businesses around, but it’s not all child’s play.
Going into childcare with only dollars in your eyes without a genuine interest in developing a top quality educational offering for the kids can easily lead to failure. Mums can be the most discerning buyers of any product or service, so if you give them any reason to not feel comfortable with the centre and staff that look after their precious little darling, they’ll not only take their child elsewhere, but they’ll also broadcast it all over the local Facebook groups. In childcare, the breakeven point is usually about 55, 60% occupancy level, so as much as the profits can be outstanding north of 85%, it can also be a shocking cash burn if you can’t keep it above 60%.
So let me share a story. Two mates with plenty of experience in property, including as sales agents and developers, had seen just how good the business of childcare can be. But, with very busy lives in their other full-time jobs and ventures, they needed more time to be completely hands-on. A deal was struck with a very well established operator that provides a full management service on a monthly fee basis.
The business would be owned by the guys, with their input and oversight, but with all the heavy lifting undertaken by the third party management company.
Here’s the catch. The benefit of a long-term lease to a third party operator, as in just being a property investor, is that it makes debt funding much easier. In the bank’s eyes, you have a known and certain income stream to service the debt. Assessing serviceability is a piece of cake. The main focus becomes who the operator is? How many centers do they have? How well do they operate? i.e. How will they be able to afford the rent?
But when you’re going to own the business as well, all a bank has to work off is your financial forecast and the valuer’s assessment of that, literally “we hope we’ll make this much profit after this much time, trust us”. If you already own at least a few childcare centres, that’s not too hard for a bank to get confidence in because then it can be clearly seen how well you already run those other centres.
How much profit do they make? What’s their occupancy? But if this is going to be your first centre, to be brutally frank, there is a decent degree of hopes and prayers. Build it, and hopefully they’ll come. Hopefully you’ll attract the right staff, particularly the Centre Director. Hopefully your marketing will attract inquiry. Hopefully your building design will look great and function well.
Plenty of people have stuffed it up before, so why should a bank trust that you won’t be one of them?
Long story short, through a process of encouraging confidence in a bank, through evidencing what would be done, who was at the helm, the track record of the management company, the veracity of the forecasts and other factors like that, we struck a deal with a bank.
Being first timers, the leverage was not through the roof. The clients did need to provide a reasonable amount of equity via a mix of cash and other real estate security to get the deal done. The effective gearing against the childcare center was just over 50%, but keep in mind that this is on the “Going Concern” valuation.
Which includes both the real estate value AND the anticipated value of the business based upon the forecasts, the valuer adopted – and that’s not an immaterial number. So this deal not only provided the client with a profitable business, but also a secure and stable long-term investment.
But here’s the deal kicker, if you’re really keen to get more into the childcare industry.
We did a previous deal, very similar -a first time operator- and after they had proved themselves by getting the first one up and running and the occupancy over 85%, the bank was then willing to increase the LVR to over 60% and then as much as 70%when they bought a second childcare centre.
Whether you’ve been thinking that you would like to get into the childcare sector or already have one and are wondering how to do a second or even already have a portfolio of multiple centers and would like to accelerate your growth even more, at STAC, we have decades of experience in childcare centre financing combined with our market leading experience in property development finance.
We’re here to help you make the right decisions at the right time for your specific needs. Send us a direct message and let’s start that journe
