Commercial property yields explained
The short version
- A yield is the annual rent divided by the price, as a percentage. A property let at £50,000 a year and bought for £1,000,000 yields 5 per cent.
- A low yield means you are paying more per pound of rent, usually because the income is trusted. A high yield means the market is demanding compensation for risk.
- The two yields you will be quoted most are the net initial yield, on the rent today, and the reversionary yield, on the rent the property could earn.
- The 2 per cent rule is a US rule of thumb with little relevance to UK commercial property, and especially not to keenly priced healthcare assets. We explain why below.
- Yield shapes finance because a keen yield means less rent per pound of price, which can limit how much you can borrow. We are an arranger, not a lender.
Yield is the word that comes up first in any conversation about commercial property investment, and it is simpler than it sounds. At its heart it is just rent divided by price. The complications come from the different versions of the rent that get used, and from rules of thumb borrowed from other markets that do not travel well.
This article explains yield plainly, separates the net initial yield from the reversionary yield, deals honestly with the so-called 2 per cent rule, and shows how the yield on a property feeds straight through into how much you can borrow against it.
What a yield is
The yield is the annual rental income expressed as a percentage of the capital value. Rent of £50,000 on a £1,000,000 building is a 5 per cent yield. Rent of £50,000 on an £800,000 building is a 6.25 per cent yield. The same rent, a lower price, a higher yield.
The counter-intuitive part is that a low yield is usually good news about the asset. It means buyers are willing to pay a lot for each pound of that rent, because they trust it will keep coming. A high yield is the market asking to be paid more for taking on more risk.
A low yield is the market's vote of confidence in the income. A high yield is its demand to be compensated for the risk.
Net initial yield versus reversionary yield
When you buy, you will be quoted more than one yield, and they answer different questions. It pays to know which is which.
| Yield | Rent it uses | What it tells you |
|---|---|---|
| Net initial yield | The rent passing today, net of costs | What the property earns you from day one |
| Reversionary yield | The estimated market rent at review or renewal | What it could earn once the rent catches up |
| Equivalent yield | A blend over the life of the income | The weighted return across the whole income |
If a property is let below current market rent, its reversionary yield will be higher than its net initial yield, because the rent is expected to rise at the next review. That gap, the reversionary potential, is part of what an investor is buying.
What about the 2 per cent rule?
The 2 per cent rule is a popular American rule of thumb that says a rental property should earn monthly rent equal to at least 2 per cent of its purchase price. On a £500,000 property that would mean £10,000 a month, or £120,000 a year, a 24 per cent gross yield.
Treat the 2 per cent rule as a piece of US folklore, not a UK benchmark. The useful discipline behind it, that the rent must justify the price, is real. The specific number is not.
What yields look like in practice
We will not invent precise figures, because yields move with the market and the asset. As a defensible illustration, prime UK commercial yields have generally sat in the mid single digits in recent years, with secondary and higher-risk stock yielding more to compensate for that risk.
For current, attributable numbers, look to named market sources such as MSCI, Knight Frank or Savills and note the period they cover. We deliberately avoid quoting a precise headline figure here that could be stale by the time you read it.
How yield shapes your finance
Here is the part that matters to your borrowing. A keen, low yield means less rent for every pound of price. Since lenders size the loan against the rent, a low-yielding asset can be harder to gear than its quality alone would suggest, because there is less income to cover the debt.
So yield is not just a measure of value, it is a constraint on leverage. Test how it plays out on our affordability and DSCR calculator and sketch the repayment on the commercial mortgage repayment calculator.
How we use yield in a deal
When we assess a purchase, the yield tells us two things at once: whether the price is sensible against the rent, and whether the rent will gear up to the borrowing you want. We use it to flag, early, when a keen asset will hit the rent limit before the deposit limit.
Start from the healthcare property investment hub, see how this links to capital in how much to invest in commercial property, and read the income model in tenanted healthcare freehold investment. To restructure existing debt, see healthcare property refinance.