If I got a pound, a dollar or even a dong for every time I’m asked about yields, I would indeed not be sitting in an office in Hong Kong, I’d be retired and lying back on a boat in the Caribbean slurping rum!
Investors regularly compare potential deals against aggregate metrics, however it’s important to truly understand what you’re comparing.
This subject is a minefield and indeed I can’t even attempt to be comprehensive here, but I’ll try and cover the three main measures.
The first and simplest aggregate yield to use for benchmarking an actual transaction or deal against is Market Yield. This is a simple yield calculated by taking net effective market rent and dividing it by market capital values. This measure assumes full occupancy and does not take into account any costs associated with the transaction itself or leasing. So, if I’m looking to buy a house today and rent it out, this is an absolutely perfect metric to benchmark the yield of my house versus the market average. Similarly, if I was looking at a newly completed office tower or a development asset, this would also be a good number to look at.
Most international real estate investors are not looking to buy just one house with one tenant, nor indeed in most cases are they looking to buy a brand new asset. In reality, if an investor is looking at a deal to buy a stabilised asset such as an office tower, then the tenants are likely to have signed leases at different times based on the prevailing market rent at that time. So, this makes the situation generally somewhat more complex.
In this case, with a stabilised asset, one needs to compare the deal to an aggregate yield measure which would attempt to take account of the rent roll in the market. In an ideal world, one should compare the deal number with the prevailing Cap Rate for the market. A market Cap Rate is essentially the average yield of recent comparable transactions in the market, but you’re only liable to be able to get access to a market Cap Rate in the most highly transparent and liquid real estate investment markets in the world, like Australia.
For this reason, in markets such Asia, where there are a relatively small number of deals, then proper Cap Rates are just not available, because there’s just not sufficient transactional data to calculate them. So what is the best aggregate measure to look at in this case? The answer is Effective Passing Yield.
Effective Passing Yield is similar to Market Yield in that it assumes full occupancy and excludes transactions costs, but what it attempts to do is to simulate the rent roll in the market. Essentially, it’s calculated by taking the average of the market rent over the average lease term in the market, and then dividing this by the current capital value of the market. By using this number, you’re able to compare your deal with the market in a more comparable fashion, because the number you’re comparing it with factors in a rent roll.
Of course any specific deal or asset will have attributes that affect the yield of that specific deal – quality, location, fit-out, tenants. That said in general, one of the three yield measures above should provide a sound basis for comparison.
Jones Lang LaSalle’s Real Estate Intelligence Service (REIS) provides a number of yield metrics to clients. I hope this simplistic look at yields serves some purpose and if you want more information, by all means pick up the phone if you’re willing to contribute a dong towards my retirement fund!
About the author
Roddy Allan is a Director, Asia Pacific Research for Jones Lang LaSalle, based in Hong Kong.