Even though he is in the slightly ridiculous position of sitting on a toddler's tricycle to pitch his business plan, Alan Proto is as serious as anyone about his big property idea.

"It's similar to the care homes sector five or six years ago," says Proto, managing partner of Nexus Pine LLP - the only commercial property fund investing in the nursery sector.  As he puts up with having his photo taken, a half-dozen inquisitive tots stare curiously at him through the French windows of the Leapfrog Day Nursery, a new-build two-storey building on a Sainsbury's car park in Enfield, north London.  "With care homes, companies like Blackstone went in and made a lot of money and now it's a recognised asset class.  The day nursery sector will be the same."

Certainly, the sector is growing.  According to the Office for National Statistics, the number of three- and four-year-olds enrolled in full-day childcare settings in England has risen by almost a quarter over the past five years, from 429,900 in 2002 to 725,115 last year.

Other hard facts also suggest that the sector is bound to rise in importance: the number of women in full-time employment has risen by 145,000 over the past 10 years to 7.6m - the highest number ever recorded; the proportion of children living in single-parent families more than tripled between 1972 and spring 2006 to nearly one in four (24%); and the government started providing free nursery vouchers to all parents of three- and four-year-olds in 1996; Proto is adamant that this trend will continue.

But recent research by market analyst Laing & Buisson suggests that the market may have peaked and that vacancy rates in the sector are starting to rise.

Yet, despite his assurances that nurseries are the next big property play, Proto is keen to point out that he's not talking about old-style playgroups run by kindly old ladies in church halls.  His nurseries are purpose-built, modern affairs, taking children from three months old until school age for up to 12 hours a day.

"The reason this sector isn't really known is that 10 years ago it didn't exist," says Proto.  "Children were either looked after by parents or relatives or by childminders in small-scale converted properties.  It's only in the past decade that we've seen large-scale operators set up in purpose-built facilities."

The Enfield operation, for example, comprises 6,100 sq ft and is registered to care for 120 children from babies to five-year-olds at any one time.  Fees depend on the age of the children, but can be as much as £228 a week for full-time care from Monday to Friday.  It brings in a rent of around £20 per sq ft.

Currently, the top five nursery operators in the UK - Nord Anglia Education, Asquith Nurseries, Just Learning, BHFS and Busy Bees - operate more than 430 nurseries in the UK, with registered places for more than 32,500 children a day, and are big business.

In December, Australian giant ABC Learning Centres, the world's largest provider of childcare services, which is listed on the Australian stock exchange with a market cap of A$2.5bn, bought Staffordshire-based Busy Bees for £71m and announced its intention to expand rapidly in the UK market.  The company has also paid $330m to acquire the second-largest nursery provider in the US, Chicago-based La Petite Academy.

Market consolidation expected

The move has crystallised interest in the sector from investors keen to buy successful, well-located nurseries that can be sold to ABC or its "big beast" competitors.  These in turn are also expected to expand aggressively, buying up smaller operators over the next two years as the market consolidates.

And, according to Proto, there is still plenty of stock out there.  He estimates that there are currently 13,500 registered day nurseries in the UK, sitting on £3bn of freehold property.  Even though the sector has grown rapidly over the past 10 years, only 10% of nurseries are owned by large operators.

Proto's enthusiasm for nurseries as a property play stems from the fact that, as a relatively new asset class, they can be bought for rather attractive yields of 7% or more, roughly the same as offices in Russia at the moment but in a more stable economy and with government childcare vouchers underpinning many of the children's fees - a sort of blue-chip government bond.

"With central London offices selling at yields of 4-5%, major investors are happy to buy nurseries off 7%-plus yields with solid income streams, guaranteed in part by the government," says Proto.  "The sector is somewhat recession-proof too, because the government gives parents of all three- and four-year-olds childcare vouchers and therefore pays a proportion of the fees itself.

"At the moment, state funding is around £50 per adult per week, amounting to around £1,500 pa.  Therefore, although nursery fees for the average child could be £220 per week, a couple with only one child in day nursery could get around £100 per week of that paid by the state.  So the covenant on nurseries is particularly good."

Despite this, few investors have ventured into the sector - and that's not just because the virgin asset class has little track record for them to rely on.  Criticism in the press of the negative effect day nurseries can have on young children as well as a number of well-reported incidents of children escaping from centres may also deter some.

Recent reports that parents are taking up their new "right to request" part-time work are also thought to have hit the nursery sector in the UK, suggesting that some growth projections for the sector may have been exaggerated.  Vacancy rates in 2006 stood at 22%, nearly double the level in 2002, although this ignores the fact that far more nursery places became available over those four years.

Moreover, the day nursery sector itself is tightly regulated by Ofsted, which has the power to close down nurseries which do not meet its standards.  Proto says this should not spark undue concern.  "Two years ago, there were 14,000 day nurseries in the UK and Ofsted closed 19.  Ofsted does not operate oppressive regulations - it will only close down nurseries which persistently under-perform."

More important for big investors, lot sizes in the day nursery sector are small and the market is fragmented.  Because only one in 10 of the UK's 13,500 registered nurseries are held by larger operators, it is fairly unusual for nurseries to be bought in portfolios.

Enter Nexus Pine, the UK Pine Fund.  Just over two years ago, Proto, the former owner of a chain of pre-school nurseries, set up the Pine Fund with Harry Hyman, managing director of AIM-listed Primary Health Properties, in order to invest in the sale and leaseback of day nurseries.

Hyman, who wanted to invest in nurseries as a good fit for PHP, which invests in the freehold and long leasehold interests of GP surgeries, agrees that the nursery sector shares a great many similarities with the primary healthcare sector of a decade ago, the time when he set up PHP.

The properties attract similar rents and are often built by developers as part of their section 106 obligations.  Moreover, like his fund for GP surgeries, much of the rent is covered by the government.

The Pine Fund's business model is simple: the company buys up mature day nursery freehold properties with a minimum of 45 registered places each, either from large operators that do not wish to own them themselves or from the freehold owners.  It then packages these up and sells off the income stream to investors at a much lower yield, pocketing the profits.

The operators are happy to realise the cash in their freehold assets and use the funds they can generate for expansion, while the investors can then tap into a high yielding sector without the bother of buying up small freeholds which they would normally avoid, considering them being small fry.

Risk-averse model

"We can say to investors such as, say, Standard Life, that we have lumps of £1m units with good rent rolls and with leases that are retail price index-linked so they don't even need to worry about rent reviews," says Proto.  "It's attractive to the risk-averse."

The principal investors in the Jersey-based unit trust are funds managed by Electra Partners Europe, which put in £12.5m of equity as well as Hyman's Nexus Structured Finance.  It was then leveraged up to £37.5m with bank debt from AIB and the Co-Op Bank.

Pine is now worth £50m and Proto and Hyman hope to "at least double that" this year.  The company has already invested £25m in nurseries across the UK, while the other £25m is tied up in deals "to be announced imminently".  Last month, the fund bought the entire portfolio of Happi Tots, the largest day nursery provider in Scotland.

And, to cater for investors just cottoning on to the idea, Pine is introducing a number of ideas to make the purchase of freeholds more competitive.  At the moment, because the asset class is so immature, day nurseries tend to be valued on their alternative use value which, as an educational establishment usually built as part of section 106 negotiations, can be rather limited.

However, in order to bid more for properties, Pine has introduced a new valuation method which prices nurseries on the income stream they produce.  And, in an attempt to make itself as attractive as possible to institutional investors, it is introducing new retail price index-linked leases to all its properties so that it is clear how much rent is likely to be accrued in any given year of a lease.

But, even with all these incentives, the real test of the day nursery property sector must be whether it will continue to grow as steadily as those in its care.