6 May 2020/ sale_commercial_property_guide

How do I calculate commercial property yield?

Investing in commercial property can be a savvy move. Leases tend to be longer than those for residential properties, with UK businesses typically renting space for around eight years. That means you could be looking at a steady income stream for a number of years. Your tenant is also likely to be in the property during the day and week, minimising the risk of needing to deal with late night maintenance issues.

But the investment will only really be a lucrative one if the rental yield is strong.

Here’s a run through of how to calculate the rental yield of a commercial property, and how to decide if the investment is worth it.

What is rental yield?

Rental yield gives you an indication of a property’s return on investment from rent. It is a percentage figure that reflects the annual rental income compared to the value of the property.

You calculate a commercial property rental yield by dividing the annual income by the property’s value and then multiplying that figure by 100. Here’s an example:

If you bought a property for £200,000 and rented it out for £1,000 a month, the rental yield would be 6%. Here’s how we got there:

 

Amount

Calculation

Property value

£200,000

 

Annual rental income

£12,000

£1,000 x 12

Yield

6%

£12,000 / £200,000 = 0.06 x 100

 

Why do you need to know the rental yield of a property?

Before you part with your money, you want to know that you’ll be earning enough to get your investment back and make a profit. Crucially, any lenders will also want to know the yield before they give you a mortgage to make sure you can afford to pay back the loan. It’s most likely that they will want to know the net yield, which accounts for costs like maintenance and insurance, but the gross yield can be a handy figure to know too.

A good rental yield tends to be upwards of 5% and around 8% is particularly strong.

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What is the gross yield of a rental property?

Gross yield is the return on income before taking away any expenses. It can be a useful guide if you’re researching different areas and want to know where your money would be best invested. You will have a direct comparison between different areas because the figures won’t be skewed by the different amounts’ landlords are spending on the properties.

You simply do the calculation above (annual rental income/property value x 100) to work out the gross rental yield.

If you’re getting to the stage where you’re starting to think seriously about a particular property, however, you will want to work out the net rental yield. 

What is net rental yield and how do I work it out?

The net rental yield of a property considers how much you’re going to be spending on upkeep, which will affect the profit you make. It gives you a clearer picture of how much you would realistically earn from the property.

To work out the net rental yield, you will need to do some research into the ongoing costs of looking after the property. Think about:

  • Any refurbishment (e.g. when was the boiler fitted? Does it need new windows?)
  • Maintenance costs
  • Management fees for the building
  • Insurance
  • Transaction costs to purchase the property
  • Cost of an agent to rent it out
  • The interest rate on your mortgage (this will probably be higher than for residential properties because of the extra risk to the lender)

Once you’ve calculated these costs, simply take the amount away from the annual rental income before doing the calculation. Let’s use the previous example. If you buy the property for £200,000 and expect to charge £12,000 a year on rent – but need to spend £2,000 on the other costs – the net yield would be 5%. Here’s how we worked it out:

 

Amount

Calculation

Property value

£200,000

 

Annual rental income

£12,000

£1,000 x 12

Net annual rental income

£10,000

£12,000 - £2,000

Yield

5%

£10,000 / £200,000 = 0.05 x 100

 

You can only work out rental yield once you have a clear idea on the annual rental income.

How do you work out the annual rental income of a property?

Working out the annual rental income of a property is a well-estimated guess. Lots of factors could affect the amount you end of up charging in rent. For example, you may choose to charge a fraction less for a tenant who wants to rent the property for 15 years rather than five.

You can gauge how much you could rent out a commercial property for by comparing others in the area. You should also think about:

  • How close is the property to the train station?
  • Are there other big businesses nearby?
  • What’s included? Will you include the costs of bills and WiFi?
  • Does the property have parking on site?
  • What sort of businesses would rent out the property?
  • Is it state-of-the-art or a particularly attractive building?
  • Is the space flexible? Would it be easy for a company to grow there?

How can I work out the capital growth of a commercial property?

Rental yield isn’t the only figure you need to think about when you’re weighing up the return of investment of a property – capital growth should also come into it. This is the amount your capital will grow as the property value increases. Essentially, it’s the difference between the amount you buy the property for and the amount you sell it for.

It is difficult to estimate the capital growth because it will depend on the market, which could be affected by all sorts of circumstances. However, you can research various areas to see by how much the property values have increased over the last five years. No growth could suggest that prices are stagnating, and your property may not increase in value by much, if at all. Fast growth, on the other hand, could indicate that the area is up and coming.

You should also consider how the area itself is changing. Plans for regeneration and new transport links could all see the area boom in a few years, which could boost property prices later down the line.

Is a commercial property investment worth it?

Whether or not you should take the plunge with a commercial property investment depends on your circumstances and the potential of the property itself. Working out the net rental yield is a good place to start and it can help you compare different opportunities.

Before you invest, make sure you do plenty of research and seek advice first. We have lots of other investor and tenant guides here, which help to answer the important questions about the commercial property market.