The yields are good, but... be careful!
When we talk about yield we talk about the financial return on a given investment.
It is a measure of profitability in percentage terms and is expressed on an annual, gross and nominal basis to the extent that it does not take into account either the costs associated with a given investment or inflation.
Calculating a yield therefore means evaluating the profit potential of a given real estate investment, not forgetting that the real yield varies over time, taking into account, among other things, fluctuations in prices and rents.
Real estate yields are determined based on transactions that occur in a specific period of time and geographic area serving a specific property segment. In addition, the rental value produced annually is considered in comparison with the acquisition and market value of the property
y = net annual income / property acquisition value
But what do real estate yields depend on?
the behavior of rents - the more rents increase, the more investors will be available to pay for a given property, which reduces the yield (= greater growth in rents, lower yield);
interest rates - being high will attract investors' attention to this type of financial assets, which could imply a decrease in property prices, increasing the yield (= higher interest rate, higher yield);
risk involved in the space and capital markets - if the investor understands that the risk in the markets is high, then these same investors will only be willing to pay little for the asset, which leads to an increase in yield. If, on the contrary, the risk is considered low, then more investors will be available to pay more for the asset, which leads to a decrease in yield (= greater risk in income, higher yield or lower risk in income, lower yield).
A real estate yield only reflects a specific moment in “Year 1” and is therefore a “short” term view.
Yields do not take into account future capital gains on leases as a component of the profitability of real estate investment, they do not consider costs, being a static measure over time that does not reflect that the annual occupancy of a property may not be total and does not It also provides for the possibility of investors resorting to bank financing, therefore not considering the debt component, removing the possibility of analyzing the potential for increased profitability through financial leverage.
It is a concept used by many property appraisers that, although it is easy to determine, will have to be analyzed together with others, under penalty of, in itself, appearing incomplete and not fully reflecting the financial return on a given investment.
In other words: yields represent the “momentary performance” of a given real estate asset and are, therefore, a mere photograph captured at a given moment and context which, although useful and valuable, do not form part of the film (even if it is a short film) which highlights the true financial return on a given investment.
In exemplary terms:
Consider properties A and B – they generate annual rents worth €14,000.00 - with property A rents being constant while in property B rents are increasing.
Both properties have the capacity to generate cash flows for a period of 10 years.
The cash flows of these properties are different because the rents for property A are constant while those for property B are increasing.
The investor hired an investment and feasibility study manager who, after doing some calculations, came to the conclusion that the probability of the properties being resold is high, estimating that property A will be resold for €140,000.00 and property B for € 154,650.00.
So, in schematic terms:
Property A (Cash Flows)
YEAR: €14,000
YEAR: €14,000
YEAR: €14,000
YEAR: €14,000
YEAR: €14,000
YEAR: €14,000
YEAR: €14,000
YEAR: €14,000
YEAR: €14,000
YEAR: €154,650
Property B (Cash Flows)
YEAR: €14,000
YEAR: €14,140
YEAR: €14,281
YEAR: €14,424
YEAR: €14,568
YEAR: €14,714
YEAR: €14,861
YEAR: €15,010
YEAR: €15,160
YEAR: €169,962
Knowing that the investor wants a return of 10%, the investment manager decided to do some more calculations and verified that the Updated Value of both properties is different.
Updated Value
Property A: €140,000
Property B: €148,932
The updated value highlights the weaknesses of an analysis that only addresses the value of yields and highlights the need to carry out a deeper and more complete analysis.
So, if you are thinking about investing, keep in mind that although yield is a good indicator, it is not sufficient for an investment decision.
It’s a case of saying “yields are good” but don’t let the profitability analysis stop there.
