Investors moving into non-residential should resist the urge to buy at low yields on the basis of recent sales. There may be special reasons.
Property yields and values
I am constantly being asked by investors about the seemingly inevitable low yields that have emerged in this strong market. A lot seem to think they have no choice but to just lie back and accept low yields.
Clearly a lot of investors don’t really appreciate how misleading yields can be. Continued strong interest for retail and industrial property is compressing yields to historically low levels, yet some low yields, particularly generally less than 6%, do not reflect the real investment story.
Investors moving into non-residential property should be on guard against selling agents that try to persuade them to buy at low yields, simply on the evidence of the low rates of return that may have been displayed by recent sales. Very often there are “non-investment” reasons for yields being so low, including:
- Property may have special value to purchasers, such as intending owner/occupiers or tenants at end of lease, seeking to purchase property to protect goodwill. In these circumstances a premium beyond investment considerations could be paid.
- Property may be bought by developers seeking consolidation for re-development in which circumstances, rental or investment yield is incidental.
- Rental may be well below market value at the time of sale with short-term prospects for strong income reversionary improvement.
- Property may have potential other than income; for example additional land, key location to redevelopment projects, refurbishment or subdivisional potential.
- Initial yields or returns on sale price can fluctuate wildly and should not readily be accepted at “face value”, when assessing prospective investments. Even in prime retail strips, for properties where the relationship between rental and capital value is balanced and the purchase is made in relation to considered investment criteria, yields are rarely less than 6%.
Prospective purchasers inclined to pay prices that will result in lower yields should do their research very carefully and seek independent advice before making an acquisition that in the medium term may not perform to expectation.