Understanding UK Commercial Property Yields

Understanding UK Commercial Property YieldsUnderstanding UK Commercial Property Yields

Investing in commercial properties can be a lucrative venture, offering a potentially stable source of income and capital appreciation. One crucial metric that investors consider when evaluating the profitability of such investments is the yield.

In the UK, understanding commercial property yields is essential for making informed investment decisions. It is a metric used by valuers to determine property values and by lenders when they calculate loan to value margins and rental incomes.

In short, the success or failure of obtaining a commercial mortgage and making the investment a success comes down to the yield.

To help, this post provides a guide to UK commercial property yields, covering what they are, how to calculate them and factors that influence them.

What Are Commercial Property Yields?

Commercial property yields, often referred to as rental yields, are a key performance indicator for real estate investments. They measure the return an investor can expect to receive from a commercial property, typically expressed as a percentage of the property’s market value or purchase price. The yield is a reflection of the income generated by the property, relative to its cost.

Calculating Commercial Property Yields

To calculate the yield on a commercial property, you can use the following formula:

Yield (%) = (Annual Rental Income / Property Value) × 100

Annual rental income includes the rent you receive from tenants, but it’s essential to factor in any additional costs, such as property management fees and maintenance expenses, to determine the net rental income accurately.

Savills commercial rental yields

Types of Commercial Property Yields

There are several types of commercial property yields, each with its own significance:

  1. Initial Yield: The initial yield, also known as the “running yield,” measures the property’s current income as a percentage of its purchase price. It doesn’t account for potential future income increases or capital appreciation.
  2. Reversionary Yield: The reversionary yield takes into account the potential increase in rental income over time. It is calculated by using the expected future rental income as a percentage of the current property value.
  3. Equivalent Yield: The equivalent yield considers all costs associated with owning the property, including property management fees, maintenance, and taxes. It offers a more accurate representation of the property’s overall return.

Factors Influencing Commercial Property Yields in the UK

Several factors can influence commercial property yields in the UK as can be seen in the chart above (produced by Savills):

  1. Location: The location of the property is a crucial determinant of its yield. Prime locations with high demand tend to have lower yields, while secondary or tertiary locations may offer higher yields due to lower demand.
  2. Property Type: Different types of commercial properties, such as offices, retail spaces, and industrial units, have varying yield expectations. For example, industrial properties may have higher yields due to lower overheads and maintenance costs.
  3. Lease Length: The length of leases with tenants can impact yields. Longer-term leases provide more income security but may have lower yields, while shorter-term leases may offer higher yields but come with increased turnover and vacancy risks.
  4. Market Conditions: Economic conditions, supply and demand dynamics, and interest rates can affect commercial property yields. A strong economy and high demand typically lead to lower yields, while economic downturns and oversupply can result in higher yields.

Significance for Commercial Mortgage Borrowers

Understanding commercial property yields is crucial for borrowers for several reasons:

  1. Investment Valuation: Yields help borrowers assess the potential profitability of a commercial property. It enables them to compare different properties and make informed investment decisions about what represents the best bet to support their mortgage application.
  2. Risk Assessment: Yields can provide insight into the risk associated with an investment. Higher yields may indicate higher risk due to factors like location or property condition. The return can be attractive but that is not always reflected in the lender’s valuation report which can be an issue if not accounted for.
  3. Income Projection: Yields allow lenders to project the annual income they can expect from the property if they had to repossess or take control in the event of default. This can be a big influence on which assets a lender will secure on and how much they will advance against each asset class. It is why different properties can be financed at different levels, care homes are a great example of this.
  4. Benchmarking: Investors use yields to benchmark their properties against industry averages, enabling them to evaluate their property’s performance relative to the market and where they may be able to gain value over time.

Summary

Commercial property yields are a fundamental metric for assessing profitability and risks associated with real estate investments in the UK. Investors/ borrowers must consider various factors when calculating and interpreting these yields to make informed decisions and to ensure borrowing for that particular property makes sense.

By understanding commercial property yields, investors and borrowers can optimise their portfolios and maximise the returns from their commercial property investments and borrow more securely. Any questions then get in touch.

By Dave Farmer