The administrator of Edge Early Learning entered into a conditional agreement with Goodstart, a nonprofit childcare operator, to sell 31 Edge-operated childcare businesses. Arena REIT (ASX.ARF) leases 27 sites to Edge, and 20 of them are included in the proposed deal. Arena’s shares have risen 18% since.

Why it matters: The deal would significantly reduce vacancy risk in Arena’s portfolio. Edge, Arena’s third-largest tenant and a source of 14% of its income, fell into administration in late August.

  • We raise our fiscal 2027 occupancy forecast to 95% from 90%, assuming the takeover is likely to go through. Arena has received all rent due to date on Edge leases and holds a bank guarantee and security deposits of AUD 4 million, equivalent to about three months’ rent.
  • We now expect like-for-like rental income to fall 3% in fiscal 2027, versus 7% previously. Our distribution forecast of AUD 0.18 per security, down 7% year on year, is unchanged.

The bottom line: We maintain our fair value estimate of $3.50 for no-moat Arena as our longer-term forecasts are unchanged.

  • Despite the rally, Arena remains undervalued. Securities are trading at a 31% discount to the net asset value of $3.60 per security, which includes the revised valuation of the Edge portfolio.
  • At the current price, the market assumes Arena would lose another one-third of its rental income without being able to replace the outgoing tenants within a reasonable timeframe, all else equal. We view a loss of that size as unlikely.

Between the lines: Edge’s struggle is another reminder of the childcare industry’s increasingly challenging operating environment, which could dampen operators’ ability to afford higher rents and, in turn, Arena’s rent growth prospects.

  • We think Arena should be able to find new tenants for most of the Edge centers over the next two years. These sites are mostly modern, purpose-built, and close to school zone catchments, making them relatively attractive to prospective operators.

Goodstart to take over 31 Edge Early Learning businesses

Arena REIT aims to deliver a reliable income stream with earnings growth prospects over the medium to long term. The predictability of its earnings is underpinned by high occupancy, long leases, and landlord-favorable lease structure. It specializes in social infrastructure assets, with a vast majority of the portfolio rented to childcare centers, and a smaller portion to healthcare facilities. Weighed down by Edge Early Learning’s recent default on rent, we expect occupancy to drop to 95% in fiscal 2027, from 100% as of June 30, 2026.

Tenants typically sign 20-year leases, which lock in annual rent increases either fixed at about 3% or linked to inflation. Overall, we estimate like-for-like rent growth will average around 3% a year over the next decade, slightly below the 10-year historical average of 4%.

All leases are “triple net,” meaning tenants pay for all statutory and operational outgoings such as land tax, water rates, and maintenance. Combined with an internally managed structure, this helps it maintain an operating margin above 90%.

Another feature is its expansion through acquisitions and developments. Historically, an average of 10 childcare centers were added to the portfolio every year, net of divestments.

The childcare industry is fragmented, with most centers privately and independently owned. But larger-scale operators are the ones that Arena tends to deal with. In the past, it has done several sale-and-leasebacks, buying a portfolio of centers from relatively well-known operators and leasing them back to the occupying tenants. Typically, it derisks development projects by partnering with prospective tenants and securing lease agreements before the shovel hits the ground.

The sector has undergone a period of booming new supply, and the industry is now saturated. However, we still see some upside in childcare demand, though it has been compressed significantly over time. The Australian government projects a small improvement in the fertility rate by 2035. This, combined with government incentives and a higher takeup rate of childcare services, could drive demand.

Bulls Say

  • The Australian government projects a small improvement in the fertility rate by 2035 due to a period of delayed family formation. This, combined with government incentives and a higher takeup rate of childcare services, could drive childcare demand.
  • Arena’s income is relatively stable and predictable. Lease terms are typically long, with fixed or inflation-linked annual rent increases. The portfolio has maintained near-full occupancy in the past decade.
  • Arena has high operating margins, thanks to triple-net leases and an internally managed structure.

Bears Say

  • The hurdles of building new childcare centers are relatively low. In the past decade, a slew of new supply was added to the market.
  • Arena’s tenant profile is concentrated. The top five tenants account for the majority of rental income, which gives them considerable bargaining power when renegotiating rent.
  • The childcare sector is highly reliant on government subsidies. A reduction or withdrawal of public funding could severely affect operators’ profitability.

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