Ray White Broadbeach commercial sales and leasing consultant Adam Grbcic is a former valuer and explains how new investors can learn from experienced buyers
There are yields and there are yields.
So often we hear about property deals and the yield that has been calculated with a simple equation — passing net income divided by the purchase price. This figure is known as Initial Yield.
But while the figure might look good in headlines, it’s not always possible to make a judgment on a property based on this reported yield and the face-value data available. There is likely to be history to an asset, such as incentives, which mean the lease is not necessarily at market rate.
When valuing a commercial property or considering a purchase, it’s risky to use this basic data to determine a price. It’s likely you’ll need the expertise and market knowledge of a real estate agent to figure out the lesser-known metric of Analysed Market Yield.
To calculate Analysed Market Income, it’s the market income — not the current income — that comes into the equation. Is the property under-rented or over-rented?
A sophisticated investor will be looking at the Analysed Market Yield because they’ll be able to recognise whether a property is rented at the market rate.
However, first time investors looking for a 6-8 per cent return won’t necessarily know the tenant is paying $120,000 per year — rather than the market value $100,000 — because the owner incentivised the five-year lease by paying for a $100,000 fit-out.
Conversely, the lease may have been structured at a lower cost to give the tenant the incentive to undertake the fit-out themselves.
Don’t get me wrong, the Initial Yield is important and often, it will be an accurate market yield.
But because there are a multitude of ways to structure a lease, it’s important to dig deeper to find out if there was a value-add or any other circumstances involved with the sale.
Let’s say a property is purchased with a dated lease in place — three to four years into a five-year lease, with low fixed reviews. (This isn’t the ideal time to sell a property, but sometimes circumstances may require a urgent sale.)
In this case, the buyer may have recognised the property had a low rental — albeit on a short lease — and decided to purchase based on this upside.
If, when doing the sums, the purchaser also took into account there was a market review in 12 months when the rent would revert to market value, then this represents Analysed Market Yield.
In cases where incentives play a role in leases, the purchaser would take this into account and adjust the income when calculating what they are willing to pay — and the return they expect to receive — for the property.
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The Gold Coast suburb of Southport is a textbook example for the importance of Analysed Market Yield.
A lot of five-year leases negotiated there in 2013 were incentivised to get people in, because the market was going through a post light rail construction recovery.
These leases are expiring in 2018 and those rentals are going to correct themselves via market reviews. This, of course, is a consideration for Southport commercial property sales right now.
It can also be the case that the yield doesn’t come into play at all. In a suburb where there is development potential, the unimproved value of the land can supersede the value of the building as an investment property.
Therefore, the yield becomes irrelevant because the income is merely holding income.
It all comes down to due diligence. The lease you read won’t necessarily attach the incentives that were involved with the negotiation. It’s usually a deed between the current owner and the tenant.
Judging the market on reported yields is inaccurate and can mislead owners and buyers. Not even valuers know all the circumstances behind a deal.
Real estate agents are the best equipped to advise because they have access to the right data and know the deals best.
- For expert advice on buying or leasing commercial property on the Gold Coast, contact Adam Grbcic