What is a yield?

The Polish Real Estate Management Act established four methods to value real estate. On the retail, office and industrial investment markets, the use of the income method is one of the most widespread.

Properties generate an income which can be forecast so the following formula can be used to estimate a property’s value from its fixed income:

property value = fixed annual income from the property / capitalisation rate

The capitalisation rate on the commercial real estate investment market is also called the yield. As an income generated by a property is normally relatively stable, its final price can be determined by its yield. In fact, you can say that an investor is in fact purchasing the income stream generated by a property. For an investor, the yield is actually the expected gross rate of return from an investment.

What determines whether a yield is high or low and whether the income stream is cheap or expensive to acquire is the investment risk of a property and the state of the investment market, including how profitable alternative investments are. The eventual price is dependent on both the premium for the risk and the law of supply and demand.

Prime properties such as high-quality office towers in the centre of Warsaw, dominant innovative shopping centres in Poland’s largest cities and modern industrial parks in top locations carry a low investment risk, and therefore have lower yields. Income generated by such properties appears to be more expensive, because the risk of it falling over the coming years is low. Such assets are targeted by risk-averse investors such as insurance companies.

By contrast, older office buildings on the outskirts, shopping centres with low footfall and logistics parks that do not meet tenant requirements have higher yields since investors seeking to acquire such properties offer lower prices to compensate for the higher investment risks. Such risks might include difficulties in finding tenants which pushes the annual income generated by the property down.

Consider a prime office building that generates an annual income of EUR 10 mln. An investor targeting this property after estimating the investment risk might submit a bid with a 5 pct yield. This means that the investor is prepated pay EUR 200 mln for the office building (EUR 10 mln / 5 pct = EUR 200 mln). If the bid is accepted, the property will generate annual income of 5 pct for the price paid and, after twenty years, its total income will be the same as the acquisition price, so the investment will pay for itself in twenty years.

The chart below shows prime property yields in Poland over the last 15 years. Yields have been moving in since 2003, which has been driven by the maturing of the market with investors considering Polish assets to be increasingly safe as well as by quantitative easing. Nevertheless, yields in Poland remain higher compared to those in Western Europe (for instance, according to Cushman & Wakefield’s Global Investment Atlas 2019, office yields stand at 2.5 pct in Germany, 3 pct in France, and 3.5 pct in Spain) and the Polish commercial property investment market continues to set new highs.