Within property investment, the finances that are involved in the actual investment are crucial to the success of the investor and their overall portfolio.
It is imperative that investors calculate their return on investment before they purchase each property that they are looking at, to ensure that it is going to be beneficial to them to go through with the investment.
The investor would need to thoroughly understand the market, and what is needed to complete the investment process efficiently.
Property yields and return on investment is an important element that needs to be understood by potential investors, as the return of money is the sole reason as to why most property investors do indeed invest in property.
However, there are simple calculations that are needed in order to work out the yields and returns on investment.
The yield that a property produces is an annual return on the investment, typically a percentage of the capital value of the original investment. There are three main types of yield within property investment that different types of investors may benefit from, including Gross Yield, Net Yield and what is known as All Risks Yield.
This type of yield is based on the return on investment before any expenses you may have, are deducted. This type of yield can be calculated by a simple calculation that sees you divide Annual Rent by Property Value to get your Gross Yield.
The Net Yield of a property is return on investment that you have after your expenses for that property have been deducted. There can be several outgoing costs that affect the total Net Yield, including repairs and maintenance, rates and insurance, management fees and transaction costs, all of which could be significant to the total Net Yield.
The way to calculate the Net Yield from your property is to subtract operational costs away from the annual rental income, and then divide that figure by the value of the property.
This type of yield is particularly relevant to investors investing in commercial property as valuation professionals, chartered surveyors and property valuers will use to showcase risks that certain investments may have.
To understand an all risks yield, there are certain things that need to be considered, including the fact that within an increasing property market, property yields are likely to fall due to the market demand forcing property prices up, whilst rent stays static, at a lower percentage of the total value.
Despite this, if the property market falls, the yields are likely to increase due to a higher percentage of the total value.
In order to generate an estimate for the capital value of a property, a percentage yield figure is commonly used as a multiplier against the annual rental income of the property. Many investors wonder why the focus is on property yields or returns, rather than any capital yields.
However, this is because capital values can generally only be determined by looking at previous transactions of similar properties of a similar location, whereas property yields are comparable throughout different properties.
An important point to make is that investors need to be aware that figures can be manipulated in a way that will show alternative capital values reflecting more accurate investment risks, meaning that the risk to the investor of renting a property can be fully taken into account.
A tenant that is known to be reliable, is at least financially stable and has a positive reputation will pose as a lower risk to the owner of the property. Therefore, as the property is occupied by this specific tenant, the value of the property will be higher to an investor as there are fewer risks involved. This is often called covenant strength, used by investors to display the quality of a commercial tenant.
A reputable, thriving company would be deemed a strong tenant because they are viewed as being able to continue to pay rent on time and not have any problems in relation to the agreements in place. Therefore, if tenants are the complete opposite of a strong tenant, they may be a higher risk to the investor.
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Our glossary of terms contains a comprehensive guide to various property investment related terms to give you a better understanding of the language and terminology used when talking about investing in property.Find out More