Understanding the importance of commercial property yields

What is a yield in commercial property?

If you’re thinking about investing in commercial property, the yield you can expect - that’s the annual return on your investment - is a crucial part of your purchasing decision. 

Here we explain what a commercial property yield is, how you calculate it and what factors affect it. We also look at the yield you can typically expect on different types of commercial properties. 

How is rental yield calculated?

A commercial property yield is the total annual return on a commercial property investment, expressed as a percentage. This is how you can calculate yield::

Commercial Property Yield = Rental Income + Capital Growth / Purchase Price x 100

As an example, if you buy an office building for £500,000 that generates £20,000 in annual rent and grows in value by £20,000 a year, you’ll have a yield of:

£20,000 + £20,000 / £500,000 x 100 = 8%

It’s also common to see commercial property yield calculations that only use rental income and not capital growth. Whilst including capital growth in your calculation can give a more accurate picture of the total return on your investment, it’s also argued that with unpredictable market conditions capital growth can only be measured accurately after the event.

Are commercial property yields net or gross?

Both gross and net commercial property yields can sometimes be used, so it’s important to understand the difference between them.

Gross yield is the total return on a commercial property before your costs, such as mortgage interest, maintenance costs, insurance and void periods, have been deducted.
 
Net yield is the return your investment generates after all your operational costs have been deducted. Therefore, it gives you a better idea of your actual return.   

The yields you see advertised by agents are gross yields, which don’t include any of your costs. It’s in the best interests of agents to advertise high yields, but this can lead to lower returns than you might expect. That’s why you should always perform your own yield calculations that include your costs when considering an investment.  

Factors which affect commercial property yield

As we’ve seen, the actual calculation you need to perform to determine the commercial property yield is relatively simple:

Commercial Property Yield = Rental Income + Capital Growth / Purchase Price x 100

But what’s more difficult is getting an accurate figure for the different elements involved. There are lots of factors that determine the rental income and capital growth of a commercial property, and that can make it difficult to calculate the yield. That’s particularly true in turbulent economic times, when fluctuating demand, interest rates and the availability of properties all increase the uncertainty.

This is why, before deciding on any commercial property acquisition, you always should seek the assistance of experienced professionals in this area, such as Eddisons. Rather than relying on inflated yield figures from the agent, our RICS-registered valuers can help you ascertain the property’s true market value and the likely capital gain and rental income to produce an informed yield figure.

A valuation expert will consider a broad range of factors, such as the property’s condition, its location, whether a tenant is in situ, and to an extent, how financially successful that tenant is in their operation at the premises. They’ll also look at wider economic factors that can affect yield. For example, the yield will typically increase when there are fewer similar properties and when finance to acquire properties is cheap and readily available. Yields in the commercial property sector can also be affected by rental growth resulting from an upturn in the economy or changes in legislation.

Determining yields for development land is more complex. Planning issues, construction complexities, local authority levies and regional issues all conspire to make sales values for commercial units notoriously difficult to predict. Developing land can also be a high-risk venture, and this risk needs to be accounted for within the yield assessment. Again, this is something we can help you with. 

Typical commercial property yields

It’s worth pointing out that not all commercial properties are equal when it comes to their yields. We’ve already discussed how location and demand can affect the yield, but yields can also vary according to the property type. 

Within general investment property, you have the individual categories of retail, office and industrial commercial property, all of which come with their own pros and cons. Generally speaking, commercial property produces higher yields than residential property. But as these figures show, yields also vary considerably according to the commercial property type.

As an example, offices in London’s West End currently (2023) generate average yields of 4%. That compares to 5.75% and 6.25% for provincial offices and offices in the South East respectively. Shopping centres and leisure parks are currently generating some of the highest yields at 8% and 7%, while high-street retail investments (6.5%) are also performing well. 

What is a good commercial property yield?

If you want to build a strong, long-term income with the potential for good capital growth, commercial property can be an excellent investment. The yields are typically higher than residential property, but so are the risks. That’s due to the higher costs involved in commercial property and the fact that commercial tenants usually take longer than residential tenants to replace. 

As we’ve seen, commercial property yields can range from around 4% up to 10%. What represents a good return will depend on your investment objectives. Some investors simply want an income that’s greater than the cost to finance the property, while others need an income to live off. Your return should also outweigh the risk of investing. 

Get the right advice

No one can be an expert in all the variables associated with commercial property, so it’s important to get advice from a team with in-depth knowledge of the specialist areas involved. Find out more about our commercial property valuation and investor property management services or get in touch to discuss your investment with our team.