Commercial Property Yields: What you need to know before investing

As with any investment, doing your research beforehand is critical and for commercial real estate, this means understanding commercial property yields.

While initial net yield is typically provided in commercial property reports, investors should be wary of relying only on this simplified figure, which doesn’t take into account all potential investment costs.

Following are some key areas to consider.

Gross vs Net Yield

Firstly, let’s avoid any misunderstandings in relation to the word ‘yield’. Generally, a yield refers to the percentage of return you receive on the purchase price.

A gross yield is the total rent you receive before you deduct any of your costs (property outgoings). A net yield is typically the total rent you receive after deducting your property outgoings (council rates, water rates, strata levies – if strata title, land tax, building insurance, etc).

This makes a huge difference to the viability of an investment opportunity so be sure to note if the property is advertised with a gross or net yield.

How is commercial property yield calculated?

Commercial property yield is calculated by dividing the annual rent (gross or net) by the purchase price. Eg. A property with a rent of $30,000 per annum + GST divided by a purchase price of $500,000 would show a yield of 6% (i.e. $30,000 / $500,000 x 100 = 6%).

A gross yield is rarely used in the context of commercial property and is more frequently associated with residential property investment.

Residential property is almost exclusively offered to renters with an asking rent that includes the base property outgoings, so it naturally follows that residential investment properties are marketed showing the base ‘gross’ rental return and therefore a gross yield.

Commercial properties are commonly marketed with a net rent, meaning tenants are charged the base property outgoings in addition to the base rent. However, it is not uncommon in commercial property that a gross rent is marketed, where the base property outgoings are factored in to the asking rent. It is, however, very uncommon for commercial properties to be marketed for Sale showing a ‘gross’ yield.

If the property has a lease with a ‘gross’ rent structure, any marketing agent should calculate the total cost of the base property outgoings, then deduct this from the ‘gross’ rental return in order to determine (and market) the effective ‘net’ rental return (or yield), then market the net return.

True Investment Cost

While the above notes on a ‘net’ yield are what is most commonly referred to in marketing of commercial properties, many investors will look at their other associated investment costs to determine a true yield.

Some of the other costs that an investor may take into account to determine a true net yield include:

  • Financing costs (interest charges / loan repayments)
    • Any property outgoings not recoverable from the tenant (eg. Property Management Fees, Land Tax if you own multiple properties – your tenant may only be liable to pay land tax as if it were the only property you owned, entitling them to threshold benefits)
    • Contingency for the property costs not recoverable from the tenant (eg. Repairs and maintenance that the tenant may not be liable for)
    • Accounting costs (this cost may vary greatly, depending on what depth of work your accountant does, and how complicated your property portfolio structure may be, including whether it is owned under an SMSF structure)

We have noted this briefly already, but it is vitally important to review a commercial lease thoroughly to understand what the tenant is liable to pay, as this will impact your true return. Some key areas to review are:

  • Base property outgoings (council rates, water rates, building insurance, land tax, strata levies)
    • Other property outgoings (fire safety inspections/certifications/repairs, air conditioning servicing/repairs/replacement, property management fees)
    • Other property costs (general repairs and maintenance liabilities)

Once you have an accurate idea of all of these associated costs, you can determine your true yield / return by the further deduction of these costs from your ‘net’ return / yield.

Return on Cash

This is a measure of what true return you achieve on the amount of cash you are putting into the property purchase, rather than just calculating the return on the purchase price. The value of this is to determine what ‘return’ you get on your cash investment, as a comparison tool against other investments you may make with your cash in other markets (say shares).

Let’s look at a quick example for calculating this return. In this example, we will assume a net annual rent of $30,000 per annum + GST, a purchase price of $500,000, up front cash investment of $150,000 (30% of the purchase price), and borrowing at 2.95% on a 25-year loan term (Please note: for simplicity, this equation does not account for any variation in interest rate over the term of the loan and it doesn’t take into account the stamp duty payable on the property, which presently would equate to approximately $18K).

From this information, we can determine the following:

  • Loan repayments are approx. $19,812 per annum
    • Net rental income of $30,000 per annum reduces to $10,188 per annum, after loan repayments
    • Net income of $10,188 / cash investment of $150,000 = 6.79% (i.e. $10,188 / $150,000 x 100 = 6.79%)

The above doesn’t take various other factors into account, such as rental growth, fluctuation in loan repayments, but it does serve as a simple approach to calculating the immediate return on your invested cash.

Depreciation

This is an area overlooked by too many investors, in our experience. Most investment properties will be able to achieve some form of tax benefit through depreciation allowances.

If you own an investment property, you should engage a tax depreciation specialist (such as BMT & Associates) to assess your property and determine what benefits you may be entitled to receive.

A tax depreciation specialist will prepare a report for you, outlining what depreciation benefits are available for your property, which you should supply to your accountant. Your accountant will then include any depreciation benefits you are entitled to as part of your overall tax review and returns.

This may result in bolstering the overall return you receive from your property, or reducing your tax liabilities.

Please note: This is only general commentary and something all investors should educate themselves on thoroughly. If in any doubt, speak with your accountant and a qualified depreciation specialist today.

If you’re looking for your next investment opportunity, please call one of our friendly team today to see how we can assist.