By CEO of Galetti Corporate Real Estate, John Jack
Returns (or yields) determine the value of a commercial property, with the general rule of thumb being the lower the price of purchase in relation to the rental, the higher the yield.
Simply put, the yield is calculated by taking your annual net rental income received from the property and dividing it by the amount invested. Depending on your investment objectives, one needs to consider short-term cash flow or long-term capital growth.
Adding to this, capital growth rates in commercial real estate are predicted to be relatively low in comparison to previous years, therefore yields are a key factor in determining whether to invest and what the return on investment will be.
Now, in one of the most economically and socially calamitous years yet, we are seeing lower yields than ever. Interestingly, the yield spread between long and short-term leases makes for a peculiar landscape across the commercial, industrial, and retail property sectors.
Investors are paying a premium for long-terms leases in excess of 10 years which will help to minimise the impact of negative reversions in the short-term; on the other hand, shorter leases under five years are ‘oversold’ with an easy 300-basis point spread between that and a 10-year lease. Historically this would have been closer to 100-basis points.
Long-term Leases are Key
Naturally, most landlords would prefer to ride out the rental reversion storm by securing a long-term tenant.
While short-term rentals in the commercial space are proving popular and can be profitable, they present greater risks for landlords and investors. Investors are looking for income security in the long-term. In exchange for lower yields, there’s lowered risk, improved cash flow profile and income security.
Areas for Growth and Opportunity
Up until the beginning of 2020, a favourable yield for a long- term lease was around 9%. However, lately we are seeing bids in the region of 7,25% for long-term leases which is a combination of risk off demand and a low interest rate environment.
Excess Supply Impacts Rentals
The rise in short-term leases and increased sub-letting activity places further pressure on an already strained market. Sub-letting is also proving to be major competition for landlords where tenants are often able to undercut an existing landlords’ best proposal.
Final Advice from John Jack
Our best advice for landlord and investors is to offer rental incentives in the interim to secure long-term leases.
