City Living: Bamboozled by estate agent speak? Ever wondered how you can get a higher yield but a lower price?
All professions love their technical terms and mysterious jargon and estate agents are no different. With the help of Andrew Gunne of commercial Property Advisors CB Richard Ellis Gunne which specialises only in the largest commercial transactions, City Living has complied an easy guide to understating property jargon when investing in commercial property.
Yield: There are essentially two types of yield - gross and net. The gross yield is simply net income divided by the net purchase price. Net income is the rent you receive excluding the service charge, management fees and rates, all of which are usually paid by your tenant anyway. In other words if your rent is €100,000 a year and you pay €2 million for the property your gross yield would be 5 per cent. (2 million divided by 100,000)
However, almost all investments you see quoted here and the UK are on the basis of net yields which include the cost of purchase such as stamp duty, legal fees and so on.
In Ireland the cost or purchase of any commercial property is 11.42 per cent which is made up of 9 per cent stamp duty and 1.42 per cent for professional fees including lawyers and property advisors as well as VAT. To work out the net yield of the €2 million property you need to add on these costs, which brings the gross price to €2.228 million, your net income is still €100,000, which gives a net yield of 4.5 per cent.
The system is exactly the same in the UK except that the cost of purchasing commercial property is lower because stamp duty is less. In general the cost of purchasing a property is 5.75 per cent which is made up of 4 per cent stamp duty and 1.75 per cent for professional fees including lawyers and property advisors as well as VAT. So in the UK that €2 million property would actually cost you €2.11 million and the yield would be 4.73 per cent.
Things are slightly different on the Continent however, and if buying there it is important to ascertain the "triple net yield", which is the technical term for the above net yield calculation. In Belgium for example the quoted yield will include stamp duty and notary costs but not professional fees whereas in France you may need to make an allowance for non recoverable costs which landlord must pay but cannot be recovered from the tenant.
As a rule of thumb if you buy something and the yield goes down you will be happy as this means the capital value of the property has increased and rental growth is good but a widening (or increasing yield) will be bad news.
Prime yield: Prime unsurprisingly means the best office or shopping locations. So shops on Henry Street or Grafton Street are considered prime. Premises in other so-called secondary locations can also have prime pitches which are usually found very close to a shopping centre, or in a pedestrianised area and so on. In the office market the prime market is considered to include the likes of Earlsfort Terrace and the IFSC. However, prime office space is still anywhere from Grand Canal Dock to the IFSC to anywhere in Dublin 2.
In retail a prime yield would assume a well laid out unit suitable for almost all possible occupiers on the 100% pitch on a prime street. A prime office assumes a core central business district (cbd) location and a grade a office building with a full spec such as air conditioning and fully accessible raised floors. Finally in retail and in offices, a prime yield will assume that the tenants have financially strong covenants or in other words that the tenant is in a good financial position.
Prime net retail yields in Dublin are around 3.25 per cent while offices are around 5 per cent. Retail yields have historically been lower than office yields because they present lower risk. Retail has also been the best performing sector for some time and yields reduce when there is strong rental growth forecasted.. In London prime offices in the West End yield around 5.25 per cent while prime retail is around 4.25 per cent.
Rack rented: Another term used in property chat is "rack rented". This does not mean exorbitant rent exacted by a Dickensian landlord but just that the rent being paid by the tenant under the lease is the same as you would expect to pay on the open market. The rent one would expect to pay in the open market is also refferred to as the estimated rental value.
Cost of borrowing: The cost of borrowing or the interest you pay on your mortgage (plus bank margin) has a big impact on the yield you are able to pay for a property investment. In Irelandthe five-year fixed rate, which is usually quoted when considering commercial property investments, is around 3.25 per cent whereas in the UK because sterling interest rates are higher the five-year fixed, or SWAP rate, is around 5 per cent. For example if you are buying that €2 million property and your yield is 3.25 per cent and your interest rate is 3.5 per cent it is easier to finance than say a yield of 3 per cent and a 5 per cent interest rate. However, in the UK your yield might be 4.25 per cent and your cost of finance would be 5 per cent. This translates into your "interest cover" which is one of the key factors a bank will be considering when deciding to finance a property or not. In other words how many times your net income covers your mortgage.
Rental growth: Most commercial property is let out on long term leases ranging from five to 25 years with five yearly rent reviews built in. The expected rental increase over the life of the investment is also a key to how much yield you are willing to pay. If a property is due for a rent review you may be willing to take a hit on the yield knowing that the rent will go up (which will bring your yield up to market level). However, if the tenant perhaps bought in at the top of the market and is paying what would now be considered to be an overrented property, you will have to wait until the rest of the market catches up before you can expect any rent increases.
Price per square foot: One should also consider the price per square foot when looking at investments. This is a very straightforward sum. For example the €2 million building may be 10,000 sq feet. That would mean a price per square foot of €200. Rents are always quoted in square feet so this should be handy way to compare the rent you are receiving to that which is available in the market.
Return: When estate agents talk about return they are looking at the return you will get over the period you intend to hold the property. Again there are two types returns, namely, geared and ungeared. Ungeared just means that you are buying for cash and not borrowing which will lead to much smaller returns than geared or borrowing. For example, if you bought a premises for €100,000 in cash and in five years time it was worth €150,000 your return would be 50 per cent over that five years (i.e. you invest €100,000 and you get €50,000 on top of this after five years your return is 50%).
However, if you bought the same property but borrowed €80,000 and put in €20,000 yourself your return would be 500 per cent (you invest €20,000 and you get €50,000 back your return is 250%) assuming the rent had paid you're your interest on your loan. Gearing, leveraging or bank borrowing, whatever way it's phrased is why property has become "the darling" of investors whenever prices are going up.
Forward fundin: The supply of good quality office and retail investments is fairly limited in Ireland as owners are reluctant to sell because there is a scarcity of what they can reinvest in.
As a result many investors are being forced to effectively "buy commercial property off the plans". This is essentially forward funding. It is often also speculative which in property terms means that there is no tenant lined up and thus It would be seen as more riskier than if there was a tenant lined up for a prelet (which effectively means that a tenant has signed to lease a property on PC, or practical completion).
