Yield: what is it, and what drives commercial property yields?
What is yield? What is the difference between gross and net yield?
You will often hear the term ‘yield’ when property investment is discussed. Discussions of residential property yields almost always refer to ‘gross’ yield, while discussions of commercial property yields almost always refer to ‘net’ yield.
What is yield? What is the difference between gross and net yield? Join us as we explore the distinction.
Commercial property is an excellent alternative to residential property investment. It typically offers higher rental returns than residential property of the same value, and there is no doubt that commercial properties can be bought at prices comparable to many residential properties.
For anyone considering commercial property investment, a key initial question is: what investment return will I receive from this property? In other words, what is its yield?
First, measuring the return on a property investment involves two components:
1. Capital return—the increase in the value of the property investment itself over time;
2. Income return—the rental income generated by the property investment.
What is yield?
Yield is an important way to assess an investment’s future income. It is particularly important for commercial property, where capital growth may be lower than in the residential market. The return you receive now and in the future is therefore a key factor in deciding whether to invest.
Yield is the rate of rental income from an investment, expressed as a percentage.
How is yield calculated?
Yield is calculated as a percentage based on a property’s cost or market value, annual income and operating costs. It does not account for increases in the property’s value over time, known as capital growth.
When calculating yield, it is important to understand whether you are calculating ‘gross yield’ or ‘net yield’. Gross yield uses total rental income before expenses, while net yield uses net rental income after all expenses, such as management fees, maintenance, council rates and insurance.
Net yield represents an investment’s net cash return and can be compared directly with returns on other investments, such as bank bond yields, share dividend yields and bank account interest rates. This is why commercial property investors always refer to net yield.
Defining yield
Yield is calculated by dividing a property’s annual rental income by its purchase cost. For example: gross yield (%) = 100 × total annual rental income / property value; net yield (%) = 100 × net annual rental income / property value.
For example, a retail shop costs $750,000. It is leased to a computer sales business for total annual rent of $56,000. Council rates, building insurance and property management fees paid by the owner total $7,300 each year.
Gross yield (%) = 100 × $56,000 / $750,000 = 7.5% per annum; net yield (%) = 100 × ($56,000 − $7,300) / $750,000 = 6.5% per annum.
Comparing Auckland yields: residential versus commercial
Commercial property typically offers higher yields than residential property, ranging from 5–15%, depending on location and risk profile, compared with 2–5% for residential property.
Residential gross yields in Auckland are currently very low, ranging from 3.4% in Highland Park to 5.1% in Papakura, according to interest.co.nz’s rental yield indicator. Net yields, after expenses, are even lower.
Meanwhile, net yields for ‘prime’ industrial properties in Auckland are around 5.8%, compared with 7.0% for ‘secondary’ industrial properties of lower quality.
What drives yields?
Commercial property yields are driven by numerous global and local factors. Interest rates, business confidence—the economic outlook—and occupancy levels—supply and demand—are the three main drivers of the commercial property market.
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All three are influenced by consumer confidence, politics and the economy. Commercial property yields are more sensitive to market conditions than residential yields because people always need homes, whereas businesses can and do fail. This risk is reflected in commercial property’s higher, more attractive yields.
Auckland’s commercial property vacancy rates are currently at record lows—for example, the industrial vacancy rate is 2.1%—with demand exceeding supply. Rents are rising, and investor demand for commercial property is strong.
Property yields explained
Demand for property is a major driver of commercial property returns. When demand is high, investment properties cost more to buy. The higher the price paid, the lower the yield, unless rental income rises in proportion to the purchase price. Falling yields are commonly described as ‘yield hardening’ or ‘yield compression’.
The reverse also applies. When property demand falls, prices decline and yields may rise. An increase in the ratio of rent to value is known as ‘yield softening’.
Yield is a measure of an investment’s expected return, rather than a guarantee. Prospective investors need to consider all other factors, including the likelihood of finding and retaining quality long-term tenants, maintenance and infrastructure costs, the property’s suitability and location, and anything else that could affect their ability to achieve the expected yield.
New Zealand commercial property offers relatively higher returns
The latest figures published by Morgan Stanley Capital International (MSCI) show that, as at March 2018, New Zealand commercial and industrial property delivered an average annual return of 10.5%, including capital growth and rental income. Asset returns reached double figures over the past 3, 5 and 15 years, and this growth trend is expected to continue over the long term.
With commercial property returns so high and Auckland house prices so high—and yields so low—it is clear that investors’ appetite for commercial property will continue to grow.
If you would like to learn more about commercial property investment, contact Haig Robinson for tailored investment advice.
Kurt Zhu – Property Broker
M:+64 (0) 21 623 688
E:kurt@haigrobinson.co.nz
Connie Lui – Property Broker
M:+64 (0) 22 061 6521
e connie.lui@haigrobinson.co.nz
E:connie.lui@haigrobinson.co.nz
This article is for information only and does not constitute investment advice. If you have any investment questions, contact a trusted financial adviser for professional advice.