How do you calculate a gross yield? The answer depends on where you ask the question. The definition changes, and cross-border investors need to understand the differences
In Europe the term “prime yield” is often used without much thought for its precise meaning. And because European markets developed independently, definitions vary between countries sometimes even within countries. Where yields are qualified at all, they are usually described as net or gross, but this does not tell the whole story. With investment markets becoming more international, it is important that cross-border investors understand these differences.
In its simplest form, “yield” comprises rent (numerator) divided by price (denominator). But which rent, and which price? A true understanding of how the prime yield quoted in one city compares with that in another requires a grasp of all the definitions and assumptions that have gone into it.
The top of the equation rent is relatively simple. A gross yield will use as the numerator the gross rent, which is the rent actually paid over to the landlord, making no allowance for any non-recoverable costs that the landlord might incur. A net yield will use the net rent (the rent after deducting all the non-recoverable costs that the landlord faces) as the numerator.
Most European countries have their own fairly standard forms of lease, so there is general agreement as to what costs a landlord is responsible for, although there is often disagreement as to how much they will typically total.
For example, Dutch landlords are unable to recover the cost of insurance, property taxes and external repairs from tenants. These are typically assumed to represent a loss to the landlord of about 8% of the rent, but this varies from building to building and there is considerable scope for disagreement as to what these costs would be for a hypothetical “prime” building.
The bottom of the equation price is much trickier. A gross yield will typically be calculated using the price before the costs of acquisition (legal fees, agents fees and, most importantly, transfer tax). A net yield should be calculated using the price after allowing for these costs.
It is here that we start to run into the first major area of dispute. Different purchasers have different costs. In particular the level of transfer tax can be affected enormously by how the transaction is structured.
Belgium is probably the best example of the impact that this can have on yield. For offices in Brussels the standard rate of transfer tax is 12.5%. However, if the transaction is structured as a company or special purpose vehicle transfer (ie a share deal rather than a direct property transaction) it will attract a registration tax of just 0.5%. Not surprisingly, many property transactions take advantage of this, hence the difficulty in identifying the true denominator to calculate a prime yield.
IPD data can be used to calculate the actual difference between the gross and net yields and test whether the market’s standard allowances are credible. In most cases the market assessment appears reasonable.
However, our research identified two major anomalies. In Ireland the difference was much smaller than the market assumes perhaps reflecting the high use of SPVs to avoid transfer tax. In Sweden, the difference is greater possibly due to underestimates of the impact of the short lease structure on landlords’ expenditure.
The market is reacting to the needs of cross-border investors; global property consultancies are co-operating to produce a single definition of yield for adoption across Europe. However, the process is at an early stage, and investors must remain alert when comparing prime yields.
Paul Kennedy is head of European research at Invesco Real Estate. Michael Haddock is an associate director in research and consulting at CB Richard Ellis.
