How to purchase real property with the highest yield
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Yield - Yield - Yield The tendency to profitable property investments increases
Definition of yield
Yield = the percentage of the return from an expenditure or investment, calculated over the time period of one year
Spring 2000: while the stock exchange market suffers from intense fluctuations and the slump of the Euro fills pages of the national and international press, a gradual stabilization on the real estate market becomes apparent. But the times where people blindly bought anything surrounded by four walls are long ago.
Mainly profitable income properties are sought-after – property investments that feature eight, nine or even ten per cent yield. Mostly wanted are “high-proof” apartment buildings, long-term leased commercial properties and large-scale real property. The reasons for such an investment are, to mention a few:
- The property, as long as it obtains outside financing – pays for itself by the rental income, that is to say, in many cases there even is a surplus left over (of about 6% interest rate currently)
- It is easier to cope with temporary vacancies (in properties with several tenants)
- The property is easier to finance because it pays for itself
- The property often is also easier to resell – provided the rules listed here are followed
- The profitability of the property is not depending on additional tax advantages
- It becomes less problematic to acquire several such properties because there is no funding gap. The credit worthiness (solvency) of the investor improves when there is debit balance through regular rental income.
In this information letter we want to go into this trend to income properties, which also will be predominating amongst decisions to do investments in the coming years. Those providers that are offering income properties will certainly be ahead of those that are selling a capital investment property with a yield of “only” four to five per cent.
Admittedly, to achieve a high yield several basic prerequisites are indispensable. Thus the key data described hereafter should help every potential investor to make a more secure decision about his investment.
Let us ask the following question at first:
How does one calculate a property’s yield at all?
Here is our formula for calculating the net yield, which we have already proposed in earlier real estate information:
Net-yield = annual net rent divided by net sales price
Formula for the calculation:
Yearly net rent multiplied by 100 divided by the net sales price
A property costs DM 500.000
The net rental income per year is (at the state of being rented out fully) DM 40.000.
40.000 X 100 = 4.000.000
4.000.000 : 500.000 = 8
So the net yield is 8%.
Many investors prefer to go by the so-called factor or multiplier when calculating the yield of a property, since this is a little more simple. The factor is not different from the multiple of the yearly net rent in relation to the net sales price.
In this example given the factor is 12,5 – so the 12,5x of the yearly net rent is the net sales price here.
So you know when you have the factor 12,5 then the property brings in a yield of 8%. Here is a table which simplifies the translation:
or, for the reverse translation:
sales price divided by the annual rent=
Many investors, especially in the commercial field, determine from the beginning on what the maximum factor may be when purchasing a property. In doing so they use the current yearly rental income as a basis, or whichever sum can be certainly applied when fully renting out. Raises of rents, tax advantages and other factors remain unconsidered at first. Many banks are working similarly today when evaluating properties for the purpose of the financing. Tenants of even the upper middle class in some areas of the new federal states for instance consider a factor of 10x for commercial objects already too high; however in good city locations in the old federal states it is common to have factors of 12 to 14x for commercial properties and 13 to 15x for residential properties.
So far so good, you will say. But how does the yield come about at all and what other factors play a role in obtaining an enduring property yield?
Let us make a note of some basic principles for that purpose:
- The location is an essential factor in the development of a yield. The better the location, the lower is usually the net yield. That makes sense, for in good or very good locations the land prices are much higher than at weaker locations as in regards to the actual building. These do not necessarily get recouped by the higher rent. Conversely, in weaker locations there are a lot of cases where yet quite a high rent is getting paid – while the land prices are low.
- Year of construction, architecture and the current condition of the building are another factor of a property. In many cases buildings with constructional defects bring in a good rent nevertheless – while reversely new or newly refurbished properties do not automatically bring in a much higher sum. The rule of the thumb can be: the better the condition, the lower the yield often is.
- The tenant plays another important role. The more secure the rental income on a long-term, the higher the sales price – which reduces the yield. Also this is no wonder: someone making a certain secure income over many years through renting contracts with high class tenants will be able to sell the property at a higher price as someone who does not have contracts for such a certain rental income.
From this follows the most important guideline when purchasing a yield property:
The higher the yield is, the more precise should one be
with investigating the location, condition and
long-term achievable income of the rents.
Yes, now you will say: so then best would be to not purchase a property with a high yield at all, in order to avoid excessive risks? Of course you can do that – and all the buyers that are left over now because they approach yield property with know-how and determination, will be happy. Because: high yield may have its price – but that price mainly consists of the willingness to bear a little higher risk. In exchange for that a property with a high yield often brings in a lot more on a long term. Let us have a look at these factors in detail now – and let us have a look at how one can use these factors to make a long-term profitable property investment – and if possible not just one time, but several times.
What requirements should one give to the location? Honestly, if you are trying to obtain an apartment building in Frankfurt, in best location, then you may not expect a yield of eight per cent. But also a property with a yield of four, five or six per cent will give you some definite advantages: first of all, there is the factor of the location security. Hardly any location has been as certain in value as the Rhein-Main area. So one could conclude that it will stay this way in future. Too many factors are hinting at it: Frankfurt being an international bank domicile, Frankfurt being the domicile of the Euro, Frankfurt being one of the most important airports of Europe, Frankfurt being a place of the stock exchange and Frankfurt as cultural world and world of happenings. Frankfurt remains to be a magnet, but not for those wanting to realize high yields.
So what does one need to look at if one wants to tackle the eight-percent obstacle?
The following experiences will be shown:
- The more you go to the south, the lower will be yields.
- The more you go to the east, the more uncertain will be the yields.
- The more you go to north, the more attractive will be the yields.
Of course these are very general statements. Even the factors “luck” and “vitamin B” (=relationships) play a vital role; it is absolutely possible, for instance, that one gets a bargain in the south of the republic and even have bad luck with the tenant in “secure” locations. But generally, the mentioned regional differences will be proven to be true.
To give a hint on the new federal states: in a book publishing five years ago we mentioned that it is best to wait five to ten years before investing here – by then a lot of excessively expensive properties and properties rented out at a rent which is higher than appropriate will be more and more sold at compulsory auctions, i.e. the sales due to compulsion or need will increase. This has proven to be true; with the result that now you will definitely be able to do profitable purchases. However, especially in the new federal states one needs to inspect the location, tenant and construction very precisely. In any case one will be able to acquire well refurbished properties here, even at very low price.
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