What is a yield? 👉 A yield is the rate of return or earnings generated on an investment over a period.It is calculated as a percentage based on the property’s cost or market value, annual income and running costs.
When looking at a yield calculation it is important to differentiate between “gross” and “net”. A net yield takes into account all expenses such as SDLT, void or irrecoverable costs, management fees etc, whereas a gross yield excludes all expenses.
Yield calculations are worked out by dividing the annual rental income of a property by its market value. Effectively, the cheaper the property and the higher the income, the higher the yield will be.
Below are three common yields used inreal estate:
- Net Initial Yield (NIY)
- Reversionary Yield
- Equivalent Yield
The above yields can be further adapted based on what period you are looking at i.e. at acquisition, when the property has become let and is stabilised, and when selling a property (at exit).
1. Acquisition Yields:
Often used in sales brochures, acquisition, or entry, yields allow you to quickly gauge the potential return you would achieve by holding this asset, and therefore allow you to compare different investment opportunities. For assets with low passing rent and/or asset management potential, sales agents will often quote the reversionary yield as well as the net initial.
- Net Initial Yield (NIY) is the net operating income (ie the passing rent less any void or irrecoverable costs), expressed as a percentage of the total acquisition costs (purchase price plus purchaser’s costs including SDLT)
- Reversionary Yieldis the anticipated yield to which the initial yield will rise (or fall) once the rent reaches the estimated rental value (ie the estimated rental value expressed as a percentage of total acquisition costs). This helps to show what asset management opportunities an asset has.
- Equivalent Yieldis the time-weighted average return that a property will produce and sits between the NIY and Reversionary. It is calculated by running a future cash flow showing each lease event and any new leases or rents as a percentage of the total acquisition costs. It can be extremely fiddly to run if you have a lot of different leases and lease events.
2. Exit Yields:
When exiting an investment, the exit yield is used to provide a suitable value to sell the property at. An exit yield uses comparative data to assess the location, quality, lease length, and tenant quality of the property, to provide a compelling exit price. They use the same calculation as at entry, except this time you are looking at the rent at exit and the gross sales proceeds.
- Net Initial Yield (NIY)is the net operating income at exit expressed as a percentage of the gross sales proceeds (exit price plus costs)
- Reversionary Yieldis the ERV at exit as a percentage of gross sales proceeds. Like the Reversionary Yield on entry, this allows a potential purchaser to see how much more asset management opportunities are left for them to pursue.
3. Stabilised Yields:
Stabilised yields, or running yields, are used to show the ongoing performance of a property as asset management initiatives take place. They can be looked at on a levered or unlevered basis.
- Yield on Costis the net operating income at a point in time, divided by the total capital costs (acquisition costs, refurbishment costs etc) to the same point in time.
- Stabilised Yield on Costuses the net rental income once the asset has become stabilised, which is normally when it is fully let, or all the asset management initiatives have been achieved.
Now that you understand the theory, do you know how to calculate the Net Initial Yield? To help you out, we’ve created a FREE Net Initial Yield calculator – grab ithere.
