Yield

Yield is the ratio between a property's annual rental income and its market value, stated as a percentage.

The term is central to the valuation of commercial property, where long and predictable leases make it possible to compare returns across properties. The lower the yield, the higher the market values the property relative to its rental income. Movements in yield are usually the single factor that drives market values the most, particularly in a rising interest rate environment.

In practice, two measures are used:

• Gross yield: annual rental income divided by the market value (before ownership costs).
• Net yield: rental income less ownership costs (property tax, insurance, management costs, ongoing maintenance, the owner's share of shared costs) before the percentage is calculated.

Gross yield is the easiest to calculate, but net yield gives a more realistic picture of the actual return. The two can differ by 0.5 to 1 percentage point for a well maintained commercial building, and considerably more for a building with high vacancy or a large maintenance backlog.

Yield is also used as a synonym for the required rate of return in a valuation: the expected return an investor requires in order to own the property, given the risk profile and alternative returns in the market. The usual approach is to calculate net rent and divide it by a yield requirement to estimate market value. If a property produces 2 million kroner in net rent and the yield requirement is 5%, the estimated value is 40 million kroner. The yield requirement is based on the risk-free rate (typically the 10-year government bond rate from Norges Bank) plus a risk premium for the individual segment.

The market often refers to:

• Prime yield: the lowest required rate of return in a segment, applying to the most attractive properties, that is, central location, solid tenants, long leases and modern standard.
• Secondary yield: the required rate of return for the same segment outside prime locations. It shows the segment's risk premium.
• Reversion yield: yield based on the expected (new) market rent after the lease expires, not today's contract rent. Used when today's rent is above or below market.
• Stabilised yield: yield based on a fully let building after current vacancy has been filled and rent-free periods are over.

Prime yield is followed closely by analysts because it quickly picks up changed expectations for interest rates, rent levels and risk. Eiendom Norge and analyst firms such as Newsec, Akershus Eiendom, Malling and Cushman & Wakefield Realkapital publish prime yield figures quarterly. For central Oslo, prime office yield has historically been in the range of 3.5 to 5%. Logistics property and retail are typically higher, and residential yield (rental homes) is normally even lower. In smaller cities, yield carries a higher risk premium, because buyers require more compensation for risk and liquidity.

Yield is not the same as return on equity. Two properties with the same yield can give very different returns on equity depending on the loan-to-value ratio and financing cost. An interest rate swap is a separate tool investors use to lock in the interest rate on their loans and so make the net return more predictable. In practical valuation, the yield method is often supplemented with discounted cash flow (DCF), where future cash flows are valued individually and an exit yield is added at the end of the analysis period.

In Placepoint, rental income, tenants and lease data for commercial buildings are shown in the property panel, and comparable transactions give a basis for reading yield levels in an area.

How it looks in Placepoint

In Placepoint, you find this in Property panel:

From Placepoint's glossary: Yield

More information: Eiendom Norge: Market reports, Norges Bank: Interest rates

English: Yield (real-estate investment return, NOI divided by property value).

Frequently asked questions

What does yield mean in the property industry?

Yield in the property industry is the ratio between a property's rental income and its market value, stated as a percentage. It gives a snapshot of the return and is used to compare properties.

What is a typical yield for commercial property in Norway?

Yield for commercial property in Norway varies by location and type of property. Prime yield for office properties in central Oslo has been between 3.5 and 5%, while properties in smaller cities typically have a higher yield.

What does a low yield mean for a property?

A low yield indicates that the market values the property highly relative to its rental income. It typically reflects low risk, a central location, a good tenant or strong demand in the segment concerned.

What is the difference between net and gross yield?

Gross yield is calculated before costs such as management, maintenance and insurance. Net yield deducts these costs and gives a more realistic picture of the investor's actual return.

How is yield used when valuing commercial property?

When valuing commercial property, you divide the rental income by the market's expected yield. If a property produces 2 million kroner in rent and the yield is 5%, the value is estimated at 40 million kroner.