The dictionary defines yield as “something that is gained in return from an input of goods or services”.
From a property perspective yield is the value of the net rental income divided by the current property value, this is also known as the capitalisation rate. It measures the cashflow that you receive on an investment normally calculated on an annual basis.
The capitalisation rate reflects the security or risk associated. Higher risk = a higher cap rate which also equates to a lower market value reflecting the shorter expectancy of the return. Lower risk = a lower cap rate giving a higher market value reflecting the expected longevity of the return. Cap rate also indicates the duration of time to recover the investment value so 6% takes 16.7 years but 10% will only take 10 years. Simply put if you want a quick return then likely there will be a higher degree of risk associated with it such as short-term leases, susceptibility to governmental changes or other external factors.
The key to effective use of yield in your decision-making process is the stability of the income stream. Commercial leases tend to be relatively stable but future risks from tax changes, market influences and zoning changes all need to be taken to account.
Generally as inflation pushes interest rates up the cap rates tend to increase as the risk factor changes although the cap rate tends to operate in a narrower range as supply and demand issues often mitigate this. We are currently seeing this happening in our markets now. Cap rates tend to range between 4% and 10%, as while below 4% is very secure, the length of time to recover the investment is too long for most investors. The opposite occurs when cap rates go over 10%, the return is good but the implied risk is often to much.
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Say goodbye to 2023, which according to many commentators had the worst commercial sales in nearly 30 years. Buyers were nervous with the cost of living and rising inflation, with high interest rates and an election season which seemed to occupy nearly 6 months of the year. While inflation is slowly trending down, there is still significant uncertainty as to when the Official Cash Rate (OCR) will begin to track below 5%. Initial expectations aimed for a midyear adjustment, but it appears more likely to be in the last quarter of 2024. With a low volume of sales for the last 18 months, data on value and returns is limited and the first question on a seller’s mind is “What is my property worth”? This is reflected in many properties being offered as “By Negotiation”, as vendors were uncertain as to meeting buyers expectations and sought to find the middle ground. Already this year we can see a change happening with prices being stated or asking for offers over a value. Construction costs appear to have stabilised and with the prospect of lower interest rates coming, the new build option becomes more attractive. As with any cycle, well designed properties in good locations have been in demand. However the challenge has been readying properties for sale or lease where factors such as location, design, layout, or value present questions for the purchaser. Those in the market for a property may need to broaden their expectations to successfully navigate deals.
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Gearing Ratios
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