|
What is a Yield in Real Estate?
While the cap rate is commonly used to discuss returns, investors should consider their yield when evaluating a prospective investment. The cap rate measures return based on a property’s current net operating income (NOI), but it doesn’t take into account future cash flows or potential for appreciation.
This is where calculating yield, specifically the Internal Rate of Return (IRR), becomes essential. The IRR factors in three key elements: purchase price, rental income and expenses over the holding period, and the projected sales price when the property is sold.
To achieve a high-yield investment, one or more of these factors need to work in your favor: purchasing at a lower price, securing favorable lease rates, or selling at a higher price. Ideally, an investor would achieve all three!
What is Considered “High Yield”?
What constitutes a "high yield" depends on the market and the type or class of industrial property. What one investor might consider a high yield could differ from another's perspective.
To truly evaluate whether an investment is a high yield, it’s essential to compare it to alternative investment options. Understanding how real estate stacks up against other opportunities will help guide your decision.
How to Identify a High-Yield Investment
To identify a high-yield investment, look for favorable conditions in at least one of the following areas: purchase price, rent, or projected sales price.
The Purchase
When assessing prospective investments, ask yourself these questions:
- Is this property priced lower than comparable properties?
- Are there improvements that could be made to increase rent potential? (Examples: adding offices, converting land for additional uses, installing more drive-in doors, etc.)
The Rent
Consider these factors regarding rent:
- Is the current rent below market rates for similar properties?
- If so, what is the lease term? How soon can you increase the rent?
- If there are vacancies, how long will it take to lease the property?
- What costs will be involved in lease negotiations (e.g., commissions, tenant improvements)?
- Is the projected vacancy rate expected to remain low during your holding period?
The Sales Price
When planning for the future, consider the following:
- What is the market projected to look like when you plan to sell the property?
- Are there nearby developments, zoning changes, or growth trends that could positively or negatively impact the property’s value?
The Challenges of Yield Projections
While it’s possible to project yield, no one can predict the future with absolute certainty. The purchase price is the easiest to evaluate since it’s based on current market conditions. However, lease rates, future vacancies, and projected sales prices are educated guesses, making them more challenging to estimate accurately.
Let’s Connect!
If you’d like to discuss your commercial real estate goals and how to identify high-yield investments, we’d love to hear from you!
| 
