What is yield?
Yield is the estimated capacity to produce a return from an investment. Alternatively, it can refer to the something that is yielded.
In commercial real estate it is most often the latter – the yield will be the estimated income return on an investment. It is generally expressed as an annual percentage rate based on either the investment cost, the market or face value at the time, annual income and running costs.
How is yield estimated?
The yield of an investment is tied to the risk associated with it – the higher the considered risk, the higher the yield potential. Commercial property yields are more vulnerable to market conditions than residential properties – people will always need somewhere to live, however business can fail. This risk is reflected in the higher yields that commercial properties attract. Commercial properties typically return a much higher yield than residential, generating yields upwards of 7% compared to yields of 4-5% in residential.
It is important to note that yield is a measurement of expected return and not a guarantee. The yield ultimately depends on a combination of factors, such as finding and retaining good, long-term tenants, overall costs of maintenance and infrastructure, asset suitability and, not least, its location and available amenities.
Another factor driving yield is demand – high demand increases the property price, which, in turn, decreases the yield estimate (unless rental income increases alongside the purchase price). This is generally referred to as “yield hardening.” The opposite happens when demand for a property decreases – yield increasing is referred to as “softening yield.”
How is yield calculated?
Sometimes it is listed as “gross yield.” This refers to the yield on an investment before the deduction of taxes and expenses and is also expressed in percentages. It is calculated as the annual return on an investment prior to taxes and expenses divided by the price of the investment at that time. The true yield is expressed as “net yield” and it reflects everything after all the fees and expenses have been taken into account. It is more accurate, but also more difficult to calculate, as most costs tend to be variable.
If the asset is a property that is part of an investment fund’s portfolio, then the “mutual fund yield” comes in. Mutual funds have two forms of yield to consider:
– “dividend yield” – is an annual percentage that expresses the income that was earned by the entire portfolio. It is derived from dividends and interest generated by the properties/investments that make up the portfolio. Dividend yield is also based on the net yield of the portfolio, over the previous 12 months.
– “SEC yield” – a standard calculation developed by the U.S. SEC, whereby the resulting figures represent net yield (see above). The main difference from the mutual fund dividend yield is that most funds calculate a 30-day SEC yield, on the last day of each month. Because it is standard and because of the shorter reference time frame, it is considered to be a fairer and more current indication of a fund’s yield.
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