For property investors the intelligent analysis of the financials behind their investment property acquisitions are crucial to their success. Investors need to be focussed on the return on investment or ROI their potential property purchase will deliver, and this is where property yield comes in to play.
To be a successful property investor you need a number of attributes… amongst other things, you need to know your market, understand what adds real value to the property buying and selling process and have tenacity and perseverance.
You also need to understand a number of property investing essentials… tried and tested tricks of the trade, evaluation techniques and other processes associated with the wider property investment arena… armed with these, your chances of success are significantly improved.
Property Yield & Return on Investment
There is however, one key principle associated with the process of investing in property that needs to be thoroughly understood and that it is the subject of property yields, or the anticipated return on investment (ROI).
Return on investment or property yield is one of the most critical components of the entire property investment process and thankfully working it out is easy, involving a fairly straight-forward calculation.
Different Types of Yield
Put simply, the yield on a property is calculated as the annual return on the capital investment and is usually expressed as a percentage of the capital value.
At an introductory level there are a number of different types of yield for a property investor to consider and these include net yield, gross yield and for specialist property investors… all risks yield.
Property Yields versus Capital Values
Many property investors often question why more emphasis is placed on property yields or returns as opposed to overall capital values… the answer to this is fairly straightforward.
Capital values on property investments can only really be generated by reviewing recent, comparable transactions of similar properties in similar locations.
Property yield however, is easily compared across a platform of properties.
Because of this, it is common practice to apply a percentage yield figure as a multiplier against a property’s annual rental income as this will help to build an estimate of the capital value of the property.
Calculating Property/Capital Values Using Rental Income
Still confused? Let’s explain further using a simple example.
If a commercial property is being let, for say one hundred and fifty thousand pounds per annum, and an approximate yield across nearly identical properties is identified at around 6 per cent, this would mean that:
Capital Value = (Annual Rental Income / Yield) x 100
In this example:
Annual Rental Income = £150,000
Yield = 6%
Calculating the Property/Capital Value:
Capital Value = (£150,000 / 6) x 100
Capital Value = £2.5 Million
Covenant Strength & its Effect on Property Yield
Moving on, investors should also be aware that property yield figures can also be “manipulated” to show alternative capital values that more accurately reflect the investment risk.
Why? Because this way the investor risk associated with renting a property can be taken in to account more fully.
For instance, if a tenant is known to be reliable, has a good reputation and is financially strong, then this will mean that they will present a lower level of risk to the property owner.
This means that the value of the tenanted property will be higher to another investor because of the reduced risk of tenant default on the rent payments.
Lease strength of this nature is commonly referred to as “covenant strength” and is a term used in the property world to denote the strength or quality of a commercial tenant.
A FTSE 100 company would be viewed as a very strong tenant, much more likely to keep to its lease covenants, to pay its rent on time and not to break any of its lease obligations.
On the flip side however, if a company that wishes to let a commercial property poses a threat of missed rental payments, broken obligations and the like, then this obviously increases investor risk and the investment value of the tenanted property will be affected accordingly, resulting in a less favourable yield.
Specialist Property Investment & Finance Solutions
As a leading independent property investment specialists Investment Property Partners offer expert advice and support to clients across our specialist areas of expertise helping them to achieve their investment objectives.
If you are a property investor looking for commercial property investments please contact us today to discuss how Investment Property Partners can help you.
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