Beyond the Headline Yield.
Assessing the quality of income and risk-adjusted returns.
Initial yield is an important component of commercial property analysis. Viewed in isolation, however, it provides a limited indication of the quality or prospective performance of an investment.
An asset acquired at an 8.0% initial yield may appear more compelling than an equivalent asset acquired at 6.5%. The key consideration is understanding why the market is pricing those assets differently and whether the additional return appropriately compensates investors for the underlying risk.
At TPA, our assessment extends beyond the headline yield. We consider the durability of the property’s income, the financial strength of its tenants, lease duration and structure, rental growth prospects, capital expenditure requirements, financing conditions and the depth of the market at exit.
What we assess
Several factors underpin our assessment of an asset’s risk-adjusted return:
- Income securityThe quality, financial strength and strategic commitment of the tenant.
- Lease profileLease duration, rental review mechanisms, options and expiry concentration.
- Rental positionThe relationship between passing rent and prevailing market rent, and the implications for future income growth.
- Capital requirementsExpected expenditure required to maintain, improve or reposition the asset.
- Capital structureThe impact of leverage, financing costs and debt terms on equity returns and downside protection.
- Exit liquidityThe likely depth of the future purchaser pool and the characteristics that may influence pricing at exit.
A compelling initial yield may warrant further investigation, but it is never sufficient on its own to support an investment decision.
Our focus is on the quality, sustainability and growth potential of the underlying cash flow, together with the price being paid to acquire that income.
Ultimately, the objective is not to maximise headline yield. It is to identify opportunities where the prospective return appropriately compensates investors for the risks assumed.
In forthcoming editions, we will examine how tenant covenant, lease structure and financing can materially alter the investment characteristics of assets that initially appear comparable.
Important Information
This material has been prepared by The Property Advisory Pty Ltd (AFSL 563650) and is provided for general information purposes only. It is intended for wholesale and sophisticated investors within the meaning of sections 708 and 761G of the Corporations Act 2001 (Cth).
The information does not constitute financial product advice and does not take into account the investment objectives, financial situation or particular needs of any person. It is not an offer, invitation or recommendation to acquire any financial product or interest in any fund.
Past performance is not a reliable indicator of future performance. Any forward-looking statements are based on assumptions that may prove incorrect. Before making any investment decision, you should obtain and consider the relevant offer documentation and seek independent professional advice.