Written by Robert Toth

Recent Regulatory Developments
The childcare industry is a dynamic sector undergoing constant change and review.
Three key developments over the past 12 months have been:

• The Fair Work Commission approving the multi-employer bargaining process for members of the relevant unions and service providers who are members of the Australian Child Care Alliance (ACA) to enter into an enterprise agreement.
• The Early Years Strategy announced by the federal government which sets out the government’s vision for the future of Australian children and their families.
• The ACCC recent review and report on the sector and recommendations to the government.

The government’s National Vision aims to deliver better outcomes for children and includes:

• Investing in accessible and affordable ECEC for the first five years of a child’s life leading to better outcomes for children in education, work, health and relationships, particularly for children experiencing vulnerability or disadvantage; and
• Support for parents and carers, particularly women, to fulfill their career aspirations through work or study to boost family budgets, grow women’s retirement savings and increase the talent and capacity of Australia’s workforce.

The ACCC review made 8 recommendations to the federal government to improve affordability and access to childcare and recommended the government take a market stewardship role and reconsider its price regulation mechanism due to unintended consequences in the sector between lower disadvantaged areas.

The ACCC found that the federal government’s childcare affordability reforms introduced last year (Cheaper Child Care) reduced the cost for families between 8.8 and 13.8% but the cost of childcare had increased by over 22% over the past 5 years for families and those savings have been absorbed by
increase fees yet again.

Some observers are concerned the sector is close to oversupply however that is not borne out by the statistics on population growth and the Government’s push to continue to support working parents. Whether it is applications for new licenses, development of new centres, or sale and purchase of existing Centres the ELC and Childcare sector is dynamic and active but also increasingly competitive with the larger corporate groups taking up greater market share!

Issues that will impact the sector in 2024/25:

1. The Federal government’s funding to support the sector over 4 years from 2024/25 will be around $84 mill (with $18.4 mill p.a. ongoing) and a further $98.4 mill to support children with special needs.
2. Lower income families will gain a larger share of the subsidy under proposed changes
3. These government subsidies help to underpin rental paid by ELC operators and therefore Investment in the industry by developers and freehold owners will remain strong.
4. Rentals based on place per child have shown significant increase from $2,000. outer metro to up to $4,000 per child inner metro higher end Centres, the average now in the order of $3,000 – $3,200 per child.
5. Continued acquisition by larger corporate groups who continue to also acquire the smaller well-run centres.
6. Greater pay and incentive for women re-join the workforce and the sector to meet higher staff child ratios and changing flexible work patterns of families.

Developers and Investors
The industry comprises approximately 13,370 businesses with the top 4 operators generating less than 40%
of the industry revenue which leaves 60% of the revenue being generated by smaller operators.

Investors
The income/return to freehold owners in the sector remains steady from 5% to 8% with good capital growth. This will improve once interest rates reduce. These are excellent returns compared to current commercial/retail property yields in the order of 2.5% to 4%.

One issue for freehold investors is that bank funding has become tighter however there are now second tier lenders who are open to lend and also private investor funds. The Banks currently lending on freehold ELC’s are the CBA and St George with others tightening their finance criteria
With good returns and long leases generally at least 10 to 15 years with options and the need for centres to meet the NQF and operators underpinned by government subsidies they are an attractive long time set and forget investment.

A recent report issued by CBRE commented that even in the face of higher interest rates and living costs the sector for investors remains steady and attractive driven by scarcity of new centres being built and with the rising cost of construction and replacement costs increased by nearly 40%, that is applying pressure on property values across most real estate sectors.

CBRE also are of the view that for investors there will be further yield compression as supply decreases and new childcare centres decline. It becomes a matter of limited supply and demand so it is unlikely investors will get yields of 6% in metro locations across Australia.

Investors should also consider despite the lower yields to take into account with new centres the benefits of depreciation, replacement costs, and comparing returns elsewhere which can increase the benchmark return on investor capital of up to 15-30% once depreciation is factored in.

Many investors are looking solely for a positive cash flow investment due to debt costs however buying a high-quality new centre on traditional borrowing parameters with a yield of 5% will still result in positive cash flow which will increase as interest rates reduce, along with the increased capital growth benefits. The average metro yield is now around 5.% to 6.30% with the current average rent per child around $3,000 per child and centres operating with 80 and 100 places.

As with any investment there are risks and the devil is in the detail so ensuring you do proper due diligence and have experienced financial legal and property advisors on board to reduce risk.

Leasing a Childcare Centre
Key issues to be aware of:

Lease term
If the lease 15 years or more and the landlord requires the tenant to contribute to any of the improvements the Lease may fall outside of the Retail Leases Act 2003 (Vic), and the protections under that Act for the operator/ tenant do not apply.

1. What does this mean for Landlords if it is 15 years or more and not a Retail Lease Act Lease (RLA)?
   i. The Landlord can legally still have an underpinning (ratchet clause) on a market rent review. This is illegal if it is a Retail Lease.
   ii. Landlords can recover Land Tax (single holding rate) which is not possible if a RLA lease and this has become a major issue in Victoria as Land tax rates have increased significantly for landholders
   iii. The Landlord can charge the tenant legal costs to prepare and negotiate the lease.
2. Operator/Tenant
   i. There are less protections to a tenant if the Retail Leases Act does not apply as it becomes a commercial lease and subject solely to the terms agreed.
   ii. There may be no right to seek a mediation via the Small Business Commissioner to resolve a dispute that arises.
   iii. The rent increases at market may not be genuine market reviews and the terms of the Lease (if NOT a RLA lease) need to be carefully reviewed.

A rule of thumb is that a tenant/ operators rent should fall in the range of 8% to 12% of their gross revenue to ensure the occupancy costs are within a range that will make the business viable for the operator.

Rent Review Issues

The other big change over the past 2 years has been in rent reviews which were tied to the CPI. For many years was most favourable to the tenant as the CPI was very low whereas now for a tenant the CPI has increased, and no one can predict where the CPI may go over the next few years.
We recommend that annual rent reviews for a tenant be set to say a fixed 3% or 4% per annum which means that the tenant can budget for that increase and those increase should keep the rent in line with a market review when it occurs in say 5 years’ time.

Pre-Lease Agreements

Building and development a childcare centre carries considerable risk and cost. It is not for the beginner! Knowing what a builder and or landlord will deliver to you as a tenant is critical and the devil will be in the detail and terms of the agreement and the detailed plans.

Often, we see an AFL which has sketch plans attached which is a risk to the tenant as to what will eventually be delivered so we suggest that the AFL provide for detailed specifications as to what a landlord will deliver to the tenant at handover, as far as infrastructure, services and landscaping.

It is the tenant not the landlord that must meet the NQF and Depts requirements to be approval for the operation of the centre, so we suggest the tenant engages its own experts to advise on the plans and process and not solely rely on the landlord /developers plans.

We have been involved in numerous AFL acting for landlord / developers and tenants and we know the issues that need to be addressed in an AFL to avoid dispute and disappointment.

The following are the key issues that need to be addressed and considered:

• Will there be a rent-free period and any Landlord contributions to the tenant’s fitout?
• Is the tenant a publicly listed company or subsidiary of a publicly listed company in which case the Retail Leases Act does not apply?
• Will personal guarantees of tenant’s directors be required? What security deposit or bank guarantee will be required?
• What are the tenant’s repair, maintenance and make good obligations?
• Who is responsible for necessary planning approval and if so for how many children which will determine the rent.
• Who is liable for the landscaping and what is included in that definition

1. Check that the Planning approval aligns with the number of children approved by the Dept.
2. Is the contract subject to finance approval?
3. What is the settlement period bearing in mind delays in registration with the Department.
4. Has the purchaser completed its financial and legal due diligence on the business.
5. What is the occupancy rate over the past 3 years and has it remained stable?
6. Is there room for growth or has it declined, if so why?
7. Check planning approval for other new proposed centres in the area that may end up as competition.
8. Has the vendor up to date financial statements and management accounts for review?
9. Wil the key staff stay on for a smooth transition and all employee entitlement and super been paid.
10. Is the purchaser an investor or actual operator?
11. Does the centre meet the current NQS and NQF framework if not, who will bear those costs?
    Sanicki Lawyers Services
    We are experienced in the industry and can assist clients in all aspects from new and existing operators,
    Leasing, Employment issues, partnership and shareholder or JV agreements and the sale and purchase of
    centres. We advise property Investor clients acquiring freeholds and know what issues to look for.
    We know the industry and have a network of consultants to assist our clients as investors , and operators in
    the ELC sector.There is no substitute for expert and experienced legal advice!

For advice on Franchising, Licensing and Distribution contact the Franchise team at Sanicki Lawyers.

Contact: Robert Toth | Special Counsel | Accredited Commercial Law and Franchise Specialist |
[email protected] | mobile – 0412 67 37 57

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