Understanding Reversionary Yield in Commercial Property

What is Reversionary Yield?

Reversionary yield is a measure of potential return on a commercial property investment. It's based on the estimated rental value (ERV) once the property reverts to market rent. This yield is expressed as a percentage of the property's current market value.

Reversionary yield is a crucial component of commercial property yield analysis. It helps investors assess the future income potential of a property, particularly when the current rent differs from market rates. This metric is especially valuable for properties with upcoming lease renewals or rent reviews, as it indicates the potential for rental income growth.

For commercial property investors, understanding reversionary yield is essential for:

• Evaluating long-term investment potential
• Identifying undervalued properties
• Assessing the impact of market changes on property returns
• Making informed decisions about property acquisitions and disposals

By considering reversionary yield alongside other yield metrics, investors can gain a more comprehensive view of a property's performance and potential.

Understanding Reversionary Yield

Reversionary yield provides insight into a property's future income potential. It's calculated using the estimated rental value (ERV) rather than the current rent. This makes it particularly useful for properties where the current rent differs from market rates.

Unlike current or passing rent, which reflects the actual income a property generates, reversionary yield looks ahead. It considers potential income changes when leases expire or rents are adjusted to market rates.

The nature of the property ownership also affects reversionary yield calculations:

• Leasehold properties: The limited duration of the lease and potential ground rent payments can influence the reversionary yield.
• Freehold vs leasehold: The ownership structure impacts long-term value and rental potential, affecting yield calculations differently.
• Freehold properties: These often offer more stable long-term returns, potentially resulting in different reversionary yield considerations compared to leaseholds.

Importance for Investors

Reversionary yield helps investors gauge the potential upside or downside of a property investment. A high reversionary yield compared to the current yield may indicate an opportunity for future rental growth, but it also signals potential risk if market conditions don't support the anticipated increase. Conversely, a low reversionary yield might suggest stability but limited growth potential, helping investors align their risk appetite with their investment choices.

Reversionary yield applies across various commercial property types, while the concept remains consistent, factors influencing reversionary yield can vary:

• Office Properties: Lease lengths and fit-out costs may significantly impact ERV.
• Retail Properties: Location and footfall can greatly affect potential rental values.
• Industrial Units: Specifications and transport links often influence future rental potential.

Calculating Reversionary Yield

The formula for calculating reversionary yield is straightforward:

Reversionary Yield vs. Other Yield Metrics

Understanding how reversionary yield compares to other yield metrics is crucial for comprehensive property analysis:

• Initial Yield: Also known as net initial yield, this measures the current income as a percentage of property value. Unlike reversionary yield, it doesn't account for future rental changes.
• Gross Yield: This considers the total income before expenses. Reversionary yield, in contrast, focuses on potential future income after costs.
• Equivalent Yield: This combines aspects of both initial and reversionary yields, providing a weighted average. It offers a more comprehensive view but is more complex to calculate.

While each metric has its place, reversionary yield uniquely focuses on future potential.

Limitations and Considerations

While reversionary yield is a valuable metric, investors should be aware of its limitations and consider several factors:

• Long-term lease distortions: Properties with extended lease terms may not reflect current market conditions, potentially skewing the reversionary yield calculation.
• ERV accuracy: The reliability of reversionary yield heavily depends on accurate Estimated Rental Value (ERV) projections. Market fluctuations or unexpected changes can impact these estimates.
• Special arrangements: Properties with peppercorn rent arrangements require careful consideration, as their nominal rents can distort standard yield calculations.
• Long leaseholds: The extended duration of long leaseholds can significantly impact reversionary yield calculations, potentially masking short to medium-term market trends.

Closing Thoughts

Reversionary yield is a powerful tool for assessing the future potential of commercial property investments, offering insights that complement other yield metrics. To make informed investment decisions, consider using reversionary yield alongside other key indicators when evaluating properties. Ready to put your knowledge into practice? Explore commercial properties for sale in the UK and start applying these concepts to real investment opportunities.

This article was updated on 20 February 2025