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 the broader market.
Instead, information on the analysed market yield should also be sought out, most likely from a specialist commercial real estate agent, as well as confirmation on whether a net or gross yield has been reported.
Without this information, uninformed buyers could find themselves out of pocket, in possession of a plummeting investment and at risk of defaulting on loans, according to Pine Property founder and commercial real estate agent, Patrick Kelleher.
“If you’re leveraged and relying upon income payments for a mortgage, then suddenly receiving less than expected rent due to a corrective market review could put you at risk of default,” he explained.
As with any investment, doing your research beforehand is critical and for commercial real estate, this means understanding yields.
Net yield vs gross yield
“Any yield that’s reported for the property will usually be the initial yield of the investment, which is purely the income divided by the sales price,” said Mr Kelleher.
“But it’s really the net yield that you’re interested in, so purchasers need to be wary. A property could be marketed at a yield of eight per cent gross, when in actual fact the net yield is six per cent after the outgoings are taken out.”
Consequently, he added that the net money received on the investment would be lower, making it critical to be aware of which yield is being utilised to market the property.
While the distinction between net and gross yield is fairly easy to determine, analysed market yield is more involved and requires information that the average purchaser is not privy to.
Analysed market yield
“From an investor’s perspective, it’s important to have an understanding of the analysed market yield, which takes into account the actual market rent,” said Mr Kelleher.
“In the commercial marketplace, any introduction of a qualified tenant will usually involve an incentive in some way, shape or form.”
“When a property is assessed, the analysis does not, and generally cannot, take into account incentives that the landlord has offered outside of the lease deal.”
For example, a property’s current rental income could be inflated because the owner provided a $150,000 fit-out when the tenant moved in. However, a market review scheduled in the next three years could correct this and bring the rent down to the actual market price.
A new owner, unaware of this deal at the time of purchase, would then see his investment negatively impacted when the market correction occurs.
While leases of three or more years are registered and available for download from the Land Registry Service at a cost, incentives are not typically recorded in the lease.
Additionally, while purchasers may engage a valuer to determine the market rent of a property, the valuer will also be unaware of any incentives that fall outside of the registered lease, unless they speak to the agent who brokered the deal, or a local commercial expert who is in tune with the market.
This is why consulting a commercial real estate agent is critical to understanding analysed market yield as they have access to the relevant non-documented information, according to Mr Kelleher.
“Commercial real estate agents are at the coalface and thus provide the best reference point to intimately understand the local commercial market and associated transactions,” he said.
“We’re often aware of the deal in its entirety, incentives included, and we’re aware of the market as a whole and what sort of deals are being transacted.”
“We also know the ownership structure, which can influence yield as mum and dad investors are rarely prepared to offer monetary incentives to finalise lease transactions when compared to a better backed and positioned institution.”
To protect themselves, Mr Kelleher said that commercial property investors should always take analysed market yield into account, understanding where the property market is at and whether a rent correction is likely to occur.
“But, of course, yield is irrelevant if there’s no security of tenure,” he added.
“If the tenant’s not financially sound and the property is likely to become vacant, then the yield is of little importance. So you need to undertake your due diligence on both the market and the tenant.”
Case Study: Oxford Street retail strip
A good example of how a potential market correction could impact investors is found in the Oxford Street retail strip.
The retail precinct suffered extensive vacancies leading up to and post the introduction of Westfield Bondi Junction due to the forced competition.
Investors that purchased a retail tenanted investment in and around this area post-introduction of the shopping centre may not have been aware of incentives that were originally offered outside of the lease in order to entice prospective tenants to take occupation in a challenging market, according to Mr Kelleher.
Additionally, there may have been and continue to be incentives on offer in established shopping centres in proximity, providing further competition in securing tenants.
Uninformed investors may have found themselves out of pocket when market corrections occurred or in the event of a vacancy in their property, creating financial stress that might otherwise have been avoided.