Equivalent Yield Explained: Evaluating Commercial Property Returns

What is Equivalent Yield?

Equivalent yield is the overall return on a property investment. It combines two key metrics in commercial property investment: net initial yield and reversionary yield. It provides a single figure that represents the property's return based on current income and potential future rental value.

Equivalent yield is a crucial metric among various commercial property yield measurements. It applies to both freehold and leasehold properties, providing investors with a standardised way to compare different investment opportunities.

When considering freehold vs leasehol property, equivalent yield calculations may differ due to factors such as lease length and ground rent payments. For freehold properties, the yield typically reflects the full income potential, while for leaseholds, it accounts for the limited duration of the investment and any ongoing lease-related costs.

Importance for Investors

Equivalent yield is a valuable tool for investors in several ways:

• It allows for easy comparison of returns across different properties, regardless of their current rental status or future income potential.
• It helps assess overall property performance by combining current and future income prospects into a single metric.
• It plays a crucial role in determining commercial property value, serving as one of the key metrics used in property valuation.
• During rent reviews, equivalent yield can provide valuable insights into how changes in rental income might affect the property's overall return.

Types of Equivalent Yield

There are two main types of equivalent yield:

• True equivalent yield: This assumes rents are received quarterly in advance, reflecting common commercial property practice in the UK.
• Nominal equivalent yield: This assumes rents are received annually at the end of each year (in arrears).

The choice between these can significantly impact yield calculations, especially for properties with frequent rent reviews or variable income streams. For long leasehold properties, equivalent yield calculations might differ due to the extended investment horizon and potential ground rent payments. These factors can influence both the timing and amount of income, affecting the overall yield calculation.

Calculating Equivalent Yield

The basic formula for equivalent yield is:

However, calculating equivalent yield is more complex than this simple formula suggests. Investors must consider several factors:

• Term rent: This is the current rental income. It directly impacts the initial part of the yield calculation.
• Reversion: This is the estimated future rental value. It affects the latter part of the yield calculation, representing potential future returns.
• Time: The period until reversion occurs influences how the term rent and reversion are weighted in the calculation. A longer time to reversion typically results in a yield closer to the initial yield.
• Lease terms: A full repairing and insuring lease can affect calculations by shifting certain costs to the tenant, potentially increasing the net income and thus the yield.

These factors are incorporated using discounted cash flow techniques, where the present value of future income streams is calculated to determine the overall equivalent yield. This method provides a more accurate representation of the property's return potential over time.

Limitations and Considerations

While equivalent yield is a valuable metric, it's important to understand its limitations:

• Unlike gross yield, which only considers current rental income, equivalent yield factors in future rental expectations.
• It differs from net initial yield by incorporating both current and potential future income.
• Equivalent yield doesn't account for property-specific risks or market conditions.
• The accuracy of equivalent yield depends heavily on the assumptions made about future rental values and timing.

Investors should use equivalent yield in conjunction with other metrics and consider the broader market context when making investment decisions.

Closing Thoughts

Equivalent yield is a powerful tool for evaluating commercial property investments, offering insights into both current and potential future returns. To make informed investment decisions, consider using equivalent yield alongside other key metrics when assessing properties. Ready to put your knowledge into practice? Browse commercial properties for sale in the UK and start analysing potential investments using equivalent yield.