Investors will often hear the term Yield or Capitalisation Rate. What is the difference between them? Essentially they are the same but are derived from different sides of the analysis. From a valuation perspective the rental is capitalised to determine a freehold capital value whilst a property that sells in the market with an income stream in place establishes the yield achieved. Either way both terms establish the same thing and that is the relationship between income (rent) and the freehold value of the asset (property).
Why is it then that yields can vary so much between assets within their own sector. We can understand why an industrial premises yield is softer than a retail premises yield but how is it that adjoin premises that seemingly are near identical can have different yields. The lease covenant will have a clear influence on that issue as one premises may have a shorter term remaining or could be over or underlet. One lease may be a gross rent and the other a net rent. The lettable area may be the same but one may have a wider frontage.
These are all issues to consider when buying a non residential property as you need to drill down into the critical issues that drive and sustain value.
You also have a choice as to what investment yields you believe best fit into your own financial situation and goals.
Do you purchase an industrial property with a 9% yield or a retail premises with 5.5% yield?
To answer that you need to understand why the yields are widely apart. The industrial yield is softer as the risk component is higher. With industrial property the availability of land and established property is more plentiful than for retail at any given time. As there is more land available to develop you do not get the growth in underlying land value as developers will enter the market and release more land when the financial opportunity arises. The industrial yield also reflects that the income is largely derived from the building structure which often, when new, comprises greater than 50% of the property’s global value. The problem is buildings depreciate and so too does the rental value of the property in relative terms to new stock that enters the market. Consequently more of the investment recovery needs to be gained earlier in the economic life of the property. Therefore the yield must be higher because there is not the compensating rate of capital growth.
Retail property on the other hand is generally limited in terms of retail or shopping precincts with the requisite appropriate zoning. In contrast to industrial property the majority of value in retail property value is tied up in the land component due to the scarcity element, ie. limited areas can be developed in established locations. As capital growth is all but assured over the medium term in recognised strips and precincts the investor has a lower risk profile and exposure and therefore retail properties trade at a firmer yield.
In the residential market there are high yields achievable in lower socio-economic localities but the higher return correlates with the higher risk associated with holding a property in these localities (eg. property damage, tenant vacancy, rent in arrears).
In contrast, premier residential dwellings produce lower yields but have far greater Capital Growth prospects.
There are a vast array of submarkets within each property sector that have different risk profiles and varying yields. When analysing property performance it is important to understand what yields are achievable, but it is more important to understand why certain yields are being achieved and where the opportunities lie.
Our Property Valuers have extensive experience valuing investment grade property throughout metropolitan Melbourne and regional Victoria and have a sound understanding of the multitude of property dynamics that can impact a market yield.
You can see the large variation in yields between commercial properties such as industrial, retail and offices by perusing the asking yields on Commercial Property Guide via the following link: http://www.commercialpropertyguide.com.au/search/for-sale/