For those who are serious about long term success in property investment, the term ‘yield’ is a very important one, as it describes the amount of net profit that exists once all is said and done. Investors need to have a clear idea of what a good yield is, in order to align their overall strategy.
So, in addition to knowing the market and how to add lots of value to properties bought, a savvy investor needs to add a shrewd and comprehensive analysis of all things financial – for to ignore this aspect, is to forget probably the most important factor of them all – what figure all of your efforts ultimately add up to.
So, in the modern property market, what exactly does a good yield look like? To really grasp what this means, the numerous different types of yield encountered in property entrepreneurism needs to be fully understood.
Basic Yields
Essentially, your property yield is worked out as the annual figure on your total investment of capital, which is often represented by a % figure of the total capital value. For newcomers to the concept, we now look a a number of different types of yield that need to be considered.
Net Yield is as you would expect – the total yield after all of your expenses have been taken away – exactly how you would have net pay after deductions in your salary. However, instead of the deductions being for tax and national insurance, your deductibles are going to be in the form of repairs, maintenance, insurance and transaction costs etc.
To gain an accurate net yield figure, you need to first take your annual gross rental yield, subtract your total expenses and then divide it by the property’s value. A figure that you will then multiply by 100 to obtain your golden number.
All Risks Yield is another concept that every investor in property investor should be fully aware of, especially if investing in a commercial property. It is especially important due to the fact that it is used by commercial valuers to illustrate the risks involved with investments..
To properly grasp all risks yield, some basic variables need to be determined. Firstly, in a strong property market, yields often drop, due to the increase in capital when set against the relative static nature of rental costs. On the other hand, in a falling market, these yields go up.
Capital Value versus Property Yields
A common trap to fall in when investing in a property is to place too much stock in the overall capital value of the property in question. There are a couple of reasons why property yields are more important:
1. The capital value is a variable that cannot really be precisely determined. All that is possible is to compare it against similar, recent transactions in similar locales.
2. Property yield is a much more scientific way to approach the calculation, as it can easily be accurately compared against properties of different sizes and locations.
Any Clearer?
For this reason, % yields are the de facto official method of establishing yield, as it can be used to create and a true estimation of the property’s overall capital value.
Don’t worry if you’re still confused, as it is a relatively complex concept to grasp. More simply put, if a commercial building is being rented out for e.g. £100,000 per year and an estimated yield on similar properties is said to be 5%, we are able to work out the exact figure we’re looking for.
So, our equations is: Capital Value is equal to (Yearly Rental income divided by Yield) x 100
Which means that: £100,000 rent divided by 5% x 100 = a capital value of £2m.
This is by the far the most accurate way to determine whether your property investment yields are where they should be.
Covenant Strength
A shrewd property investor must also know that the yield figures mentioned earlier can also be adjusted to illustrate alternative values when other risk elements are taken into account. This manipulation is not a deliberate deception, rather it is to determine the exact risk associated with renting that particular property to any given party.
As the tenants are the only other variable in the equation, having a good tenant that is financially stable and that has a good reputation is going to lower the property owner’s financial risk. Ergo, if the investor is going to see the capital value of the building as being higher, due to the fact that rental defaults are not a likely outcome.
Conversely, if a property is rented out to a tenant that is likely to renege on its obligations to pay rent, the overall value will drop, as the risk is higher and will not produce as a high a yield.
In Summary
As the subject is a relatively complicated one, we would always recommend speaking to a professional when interested in investing commercial properties. This also applies if you happen to already own one and are not in full possession of all the facts surrounding your investment.
When all is said and done, it’s the responsibility of the owner of any building to ensure that their assets are working as hard for them as they can be, so with concepts like property yields (rather than simple capital values), it’s very important that you know what yours are.
Thanks for reading and we’ll see you next time.
