Milo Spector authors perspective in GlobeSt: Early education assets in high demand by net lease investors

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SAN FRANCISCO, CALIFORNIA (March 30, 2023) - While early education centers may have been overlooked by many high-net worth investors in the past, the pandemic has reinforced just how essential these centers are as they are meeting or even exceeding pre-COVID enrollment. Throughout the pandemic, many centers stayed open for the children of front-line workers. Additionally, early education facilities have proven vital for children to have face-to-face interaction to develop social skills. And ultimately, parents need childcare, making the sector necessary.

While the early education space has not been as well-known as some other single-tenant net lease sectors, it has taken off over the last couple of years and has become much more recognized as a secure investment.

What Has Changed?
Historically, early education assets traded for higher cap rates on average than other single-tenant net lease retail properties like dollar stores, banks, and quick-service restaurants. In addition, most of the investors were institutional groups like publicly traded REITS. In general, high-net worth buyers typically had a harder time understanding the early education business model or didn’t recognize the company vs something like a quick-service restaurant or a pharmacy.

Most high-net worth investors are one-time buyers who are in a tax-deferred exchanges and being such tend to stick with businesses they know. It is much easier to feel comfortable with a McDonald’s vs. a KinderCare if you don’t know who KinderCare is, despite KinderCare being one of the largest corporate operators in the early education space with over 1,500 locations.

This concept is demonstrated by the spread between single-tenant retail cap rates vs. single-tenant early education cap rates. On average, there was an approximately 120 basis point spread between early education and single-tenant retail. However, that spread drastically dropped to about 87 basis points in 2022 – an all-time, record low. That is clear evidence that many more high-net worth investors are aggressively pursuing the early education space. This robust high-net worth investor demand has been driving down cap rates and making this spread thinner. Early education cap rates were historically low in 2022, at an average of 6.44 percent, which is 71 basis points lower than the previous year average of 7.15 percent (this data includes all credits, lease terms, and locations).

Surging Demand
In 2021 and 2022, more high-net worth investors began looking at all types of properties to fulfill their 1031 exchanges including early education, due to a lack of inventory, and some of the most aggressive cap rates ever experienced in the single-tenant net-leased sector. Over the last two years, we started seeing unprecedented demand for early education assets. We saw cap rates drop below 6 percent, which was previously unheard of in this space, and Spector set multiple cap rate records at this sub-6 percent level.

Typically, these deals were in strong locations with long lease terms and strong credit. For example, Spector sold a portfolio of two early education centers for $14 million at a 5.75 cap and had multiple offers. Spector also sold a multi-building property for $10.8 million, also at a 5.75 cap, which also drew multiple bids and closed all cash.

Sales Volume Up
Transaction volume for the early education sector in 2022 exceeded $681 million, up approximately $54 million over 2021. Both 2021 and 2022 nearly doubled the sales volumes of previous years, again a strong indicator that more buyers are attracted to the space.

In 2022, there was a significant amount of investment from the “private client” or “high-net worth” sector, with approximately 89 percent of early education properties sold to this investor type.

New listings are also on the rise. The increase in listings can be attributed to growing demand from investors, prompting more landlords to consider a sale, as well as more developers and operators looking to capitalize on the benefits of fully marketing a property.

Outlook for 2023
This year unwavering investor demand will continue for early education properties. Buyers remain attracted to the sector’s e-commerce-resistant nature, high-quality real estate, long lease terms, and escalating demand.

While the net-leased market has decelerated overall, it is by no means “dead.” While the market was in somewhat of a frenzy over the last couple of years, Spector anticipates strong sales volume again this year. Early education properties will continue to trade hands, as more 1031 buyers consider it a secure option with strong tenants.

Like every other product type, however, today’s cap rates for early education assets are a bit of a moving target due to the rapidly changing economic environment and rising interest rates. While we may not be seeing as many deals trade in the sub-6 percent range that was seen in 2022, they remain extremely low relative to where the market was historically.