Capital Appreciation versus Yield?

It’s always interesting to read in the property news how a property rental deal has been hailed as a success when a commercial property has been let on a gross yield that doesn’t, on the face of it, provide a great return.

The latest Savills quarterly review has shown for example that some prime yields have declined by up to 1% on a year on year basis, which is seen as a sign of a buoyant market.

The gross yield is of course a result of several factors, and understanding those influences is key to this.

They include:

• The best tenants long term are those with the strongest covenants, financially but also how they operate. The best tenants demand the lowest rents and landlords are prepared to accede on the rentals for a secure and long term, quality, tenancy. A low yield can therefore be a recognition of an excellent long term deal having been agreed.
• The corollary might be a high risk tenant on a poorly structured lease – the returns will appear better (I.e. A high yield) but they need to be as it will not be such a good deal.
• Capital growth, when not combined with an opportunity to uplift rentals, depresses the yield, but could be good news for the freeholder. The reduction in prime yields in Central London for example is a symptom of the influx of capital (overseas led) which has driven up capital values and depressed yields.
• A trend in yields can be a reflection of the health of a sector. For example over the last year yields for Industrial Distribution properties have reduced by about 1.5% – a reflection of a healthy sector. Yields for food stores have however risen by nearly 1% – reflecting problems in that sector. This becomes a challenge when there are concentrations of such businesses in an area or a portfolio.

The picture is therefore more complicated – and of course it comes back to the motivations and objectives of property owners: are they looking for short term gain, problem free and low risk long term tenancies or a balanced return for their investment.

These are decisions that larger and experienced investors have as clearly defined policies. However smaller and new investors sometimes lose sight of this, particularly in competitive bidding situations, including auctions of course