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Why Is Commercial Property Yield Important for Investors?

Commercial property is a type of real estate used for commercial purposes. It can be offices, shops, warehouses, or any other commercial space used to generate income. At the same time, residential property refers to a house, apartment, condominium, or another type of dwelling. 

Commercial real estate has several advantages, including affordable prices, convenient financing terms, equity growth, greater cash flows, and tax advantages, which is why many property managers and owners in Australia consider it a wise investment choice. Commercial property investments are mainly used to generate income and property owners can lease their commercial spaces to tenants looking for a place to set up their business. 

Yield on commercial property is an important aspect to determine the value of a property that investors, especially first timers should understand to best decide on any commercial property investments. Although investing in this type of property can be challenging, the returns and benefits could be worth it.

What Is Yield in Real Estate? 

The yield or rate of return measures the income generated by an investment property. Yield is determined by dividing the annual rental income by the property’s purchase price. 

This rate of return is expressed in percent form as a percentage of the asset’s value and is used to make investment decisions regarding properties. Frequently, the annual rent collected from renters for property use is used to calculate returns.

The yield on a property can be expressed as either a gross or net yield. Gross rental yield is the annual income generated by a property before any expenses are deducted. It is calculated before deducting maintenance, repairs, and insurance costs. The gross rental yield is an essential metric for real estate investors to consider when evaluating potential investments. It can be used to compare different properties and determine which will provide the best return on investment.

Net rental yield takes these costs into account and is usually lower than gross yield. You would receive the net amount in total rent after all expenses. Known as base property outgoings, the expenditures associated with land tax, mortgage & loan repayments, strata charges, utility bills in water & electricity, property insurance, and maintenance costs are all included in the net yield. They are used to determine the actual expenses of investments.

How to Calculate Commercial Property Yield? 

Commercial yield is calculated by dividing the annual rental income by the property’s purchase price. For example, if a property is purchased for $700,000 and the annual income received through that property is $52,000 then the property yield will be 7.43% (sample computation: $52,000 / $700,000 x 100% = 7.43%). 

While gross yield is important for residential properties, commercial property investors place more emphasis on net yield. If a lease stipulates gross rent, a seller should subtract base property expenses from the gross rent before marketing the net yield for the commercial property.

The time it will take to recover the investment depends partly on the rental yields. The rental yields are a good indicator of how quickly an investment will pay off. However, several variables, including property prices, location, infrastructure, interest rates, and vacancy rates, can impact commercial rental yields. 

Rental yields could decrease due to increased property demand by investors who bid higher on the property prices. Higher rental yields may result from a lack of commercial real estate supply forcing tenants to pay higher rent while the purchase price is set. An investor should take these factors into account and research the potential rental yield when buying a property.

How to Evaluate a Good Commercial Property Yield?

Good commercial property yields are determined by considering multiple variables as there are no exact numbers to state as good investment return even though some would consider 5% to 10% yields from commercial property to be a sound return.

Some factors that can be evaluated to determine a good yield include:

  • The yield from the commercial property is higher than the one from a residential property
  • The gains compensate for the risks
  • The costs associated with financing real estate, such as loans, mortgages, and interest rates are lower than the commercial property yield
  • The profit allows the investor to cover his living expenses

Commercial yields are often higher than residential yields for many reasons. One of the reasons is the difference in the leasing agreement in which commercial lease has higher rents running over many years versus residential lease that is more short term. 

The goal of commercial real estate is always to turn a profit. Therefore, it makes perfect sense that the commercial real estate owner will likewise benefit from higher rental yields if the business firm has more financial success. In contrast, the objective of residential real estate is to provide a place to live and does not have high commercial use. Consequently, they do not have a large rental yield like commercial real estate.

After properly evaluating a good commercial property yield, an investor can estimate the return of investment rates through the “Capitalisation Rate” or cap rate. Capitalisation rates are calculated by dividing the net operating income of the commercial property by its latest market value. 

Cap rates can indicate if the commercial property will have a good or bad yield and how long it will take to recover the investment from the property.

Commercial property yields in Australia can differ depending on what property was acquired and how much income it produces. You can find the statistics of average commercial yields across Australian cities in the recent year:

Cities of Australia Average Commercial Yields
Sydney 4.1%
Melbourne 4.9%
Adelaide 6.7%
Brisbane 5.3%

Capital Gains in Commercial Property 

Capital gains in commercial real estate are the profits an investor makes when they sell their property for more money than they paid for it. However, capital growth on commercial properties is slower than that of residential properties. The building depreciates while the land appreciates. Long lease agreements and low asset class liquidity in commercial property can also be factors of residential properties having more capital gains than commercial properties.

When selling a property, you must remember that you’ll have to pay capital gains tax at your marginal income tax rate. However, it’s possible to access a discount of 50% if you own the property for over a year. 

Learning how capital gains and capital gains tax work on a commercial property is very important to consider before investing in commercial properties. In this way, an investor can determine which commercial property has the highest return on investment.

Other Factors for Commercial Property Investment 

Even though the yield is crucial to investors when making commercial property investment decisions, there are other factors to consider, particularly when the yield is insufficient:

  • Future development potential – This is an aspect that investors should consider when buying a business property. A property’s prospective development can be observed and assessed based on its location, accessibility to transportation, particularly public transit, the presence of other businesses in the region that compete with it, and the population density.
  • Lease terms – An investor must determine the commercial property’s lease duration before making a purchase. Investors can use this information to estimate how long it will take to recover their investment.
  • Vacancy rates determine how the property performs in the business. Low vacancy rates mean the tenants have a positive experience living in the property, while high vacancy rates may tell the opposite.
  • Financial Situation of Investor – Financial situation and budget of the investor should always be checked when considering investing in a commercial property. Consulting a financial expert regarding the matter on hand would be a prudent move considering the huge investment.
  • Other investment priorities such as Loan Repayment – Loan repayment and other investment priorities such as mortgage must be thoroughly assessed.

Make Informed Investment Choices 

Commercial property yield is an important factor when choosing investment property. In addition, other variables such as future development potential, lease terms, vacancy rates, the investor’s financial situation, and other priority investments need to be considered aside from commercial property yield. 

As long as the investment aims and goals are sorted and the investor’s financial status is clear, the commercial property market is an excellent investment area. To have the best chance, recommendation and support from a real estate expert who knows the commercial property market can be the key to finding the right commercial property for future commercial investment.

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