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Invest or Not?

27th September 2017

Categories: Latest News

With Torbay Council recently agreeing to expand its investment fund to £200m and with the successful purchase of a number of investments already such as the Tesco superstore in Dorset and the EDF Building in Exeter, assessing possible future suitable investments is still no easy task.

Clearly, when considering investing in commercial property, the most important question to ask is what return on the investment will I achieve from a property or, in other words, what is its yield?

Yield is an important way of measuring the future income on an investment. It is particularly important in commercial property as capital growth rates are not usually as high as the residential market. So the return you get now and in the future is a key factor in working out whether to invest.

So, how do you work out yield?

Yield is calculated as a percentage, based on the property’s cost or market value, annual income and running costs.  However, it’s also important to know if you are calculating ‘gross yield’ or ‘net yield’. Gross yield is everything before expenses, whereas net yield takes into account running expenses such as management fees, maintenance costs, stamp duty, legal fees and vacancy costs.

In simple terms, the yield calculations are worked out by dividing the annual rental income on a property by the purchase price. For example:

Gross yield = annual rental income / property value x 100.

So, if we were to purchase an office block for £5.5m and rent is £350k pa, the annual return on the investment, or the yield, would be 6.36%. In short the higher the percentage yields the stronger the investment.  However, there is also a direct correlation between yield and risk.  The greater the risk in an investment whilst the returns will be higher there is also a higher probability of some form of default occurring.

The three main drivers for commercial property are yield, business confidence and occupancy rates.  All three are affected by factors such as consumer confidence, politics and the economy. As witnessed after the ‘Brexit’ vote, commercial property yields are susceptible to market conditions and this risk is reflected in the higher yields that commercial property generally attract.

Demand is one of the key drivers of yield. When demand is high, the cost of buying an investment property increases. The more one pays, the less yield you get. When yields are decreasing this is often referred to as ‘hardening yields’.  The opposite is also true. When demand for property is down, prices fall and yields can increase. When the rent-to-value ratio increases it is referred to as ‘softening yields’.

All investors need to take into account many other factors when considering an investment opportunity, such as retaining a good, long-term tenant, maintenance and infrastructure costs, suitability and location of a property and finally having a good exit strategy.

TDA is able to provide advice and support when considering property investments. 

Paul Palmer, TDA Estates Manager, can be contacted on paul.palmer@tedcltd.com

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