Every single personal interested in commercial real estate investments need to think about the return made on investment. This is what is known as yield, a figure that is to always be taken into account to measure investment future income. Here is what you absolutely need to know about it.
Defining Yield
Defining yield is not at all difficult since it is practically the potential return on investment made when you buy real estate. Property yield can be assessed for any real estate property but it is more important in commercial properties because capital growth rates will be lower than in residential markets. How much you get back is a vital factor in figuring out if the investment should be done or not.
Calculating Yield
You measure yield as percentage, based on the market value or cost of a property, running costs and annual income. Yield will not consider the value increases that happen as time passes so capital growth will not be taken into account.
If you want to calculate yield, you need to focus on both “net yield” and “gross yield”. The gross yield is all before the expenses and net yield consider running expenses like maintenance costs, vacancy costs, stamp duty and other possible fees.
Calculations are done by dividing annual rental income by buying costs. For instance, when investing in the office of a dentist Lafayette, you would have:
“Gross Yield = (52 X Weekly Rental)/100XProperty Value”
If the dentist office is a retail property that you buy at $750,000 while renting it for $78,000 per year, annual ROI, yield, becomes 10.4%. Retail business running expenses are not considered in this example.
When you calculate the ROI of commercial real estate, you get returns higher than with residential real estate. Averages are at around 7% while residential real estate has averages at 5%.
What Influences Yield?
In commercial real estate the 3 main drivers are occupancy rates, business confidence and yield. These 3 are going to always be affected by the economy, politics and consumer confidence. A commercial property yield will be susceptible to varying market conditions, in a stronger way than the residential property. People do need places where they live but businesses can always shift locations. That is why higher yield appears. You will also want to consider needed improvements to boost property value but this is not calculated into yield.
Property demand is an important driver to take into account. If the demand is high, buying the investment property will be more expensive. If you pay more, yield becomes lower. As yield decreases, the market condition is known as a “hardening yield”. Obviously, the opposite is correct and does apply.
Final Considerations
Remember that yield is basically a measurement of the expected ROI of the investment you make. It is never a guarantee. The potential investor should consider every single important factor, including likelihood of returning and finding a good, the possible long term tenants, infrastructure costs, maintenance costs, property location, suitability and more. Always be sure that you take everything into account and that you analyze as much as possible before you commit to a purchase.
