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28.05.2008Measuring the return of an investment property


Both of these concepts can also be looked at on a "before tax" and an "after tax" basis.

An investor using borrowed funds can also have regard to the net return on the investor's equity. This is obtained by dividing the rent per annum (net of the landlord's expenses) less the interest commitment per annum by the value of the property less the amount of the loan.

In contrast, returns from shares are usually expressed as a dividend yield (dividends per annum per share divided by the market price per share) or as an earnings yield (earnings per annum per share divided by the market price per share). The latter is the more useful concept, as better indicating the underlying performance including growth.

In the case of franked dividends the dividend yield really needs to be grossed-up in order to reflect the attaching imputation credits. If this is not done then like will not be being compared with like.

Should investors seeking to buy a property look for a yield of over, say, 10 per cent? Or should they be willing to accept a yield below 5 per cent? This is really a nonsense question - basically sensible investors when buying assets will normally get what they pay for.

A low initial income return can be quite acceptable provided that there are corresponding prospects for future capital and income growth. However, as always, the old adage of "the higher the return, the greater the risk" will usually apply.

Property yields are not uniform. They vary enormously according to a number of factors, including the type of property (residential, commercial, industrial, rural, and so on), its location, the quality of the building and the unexpired term of the lease.

As a general rule, older buildings will require a higher yield to compensate for the likely cost of future repairs and because they are less appealing to tenants.

Some investors pay considerable regard to the quality of the present tenant at the time of purchase, but this can be a trap because the tenant may decide not to stay on beyond the term of the lease.

Quite irrationally, yields on residential properties are usually considerably less than those on commercial or industrial properties. This comes about because of the incidence of unsophisticated investors who favour this category of investment over others despite its drawbacks, partly because they think that they can assess it more readily. They live in a house and know what to look for in other houses, but they are unfamiliar with what the attributes of a factory or office should be.

Typically, nominal residential yields might be 5 per cent or even less, with the landlord paying all the outgoings, at a time when industrial yields might be around twice this level, with the tenant paying the outgoings. Other things being equal the capital growth expectations for both categories would be roughly the same.

 

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