Investors may be being misled by quoted real estate yields across city markets, according to findings in our latest 12 Cities research.
Investor costs, plus tenant incentives, such as generous rent-free periods, can eat into return: we’ve found that, on average, investors can actually expect to see income 100 basis points below quoted yields. It’s even wider in some markets: Sydney market yields are recorded at 6.5 per cent, but we’ve calculated that effective yields are 4 per cent. The picture is similar in LA and New York, with the differences between market and effective yields of between 240 and 200 basis points. In heavily invested cities such as London, Hong Kong, Tokyo and Paris the difference is less pronounced, but it still exists.
We recommend investors should always examine the net effective yield – the actual income received as a percentage of capital employed – to give a clearer indication of expected returns. But to fully assess performance in core markets and predict the likely direction of yields, take a closer look at the NOBEY: the net effective yield with the average bond yield subtracted.
A high NOBEY indicates that there is more scope for capital growth and/or rental falls, while a low NOBEY indicates less scope and arguably less market resilience. Looking at our 12 Cities report with our NOBEY glasses on, the results show that Mumbai, with an effective yield of 7.6 per cent drops to -0.2 per cent when taking into account the returns available from government bond income. On average, our 12 Cities have a NOBEY of just 0.9 per cent, although Tokyo may be one of the most resilient with a NOBEY of 2.9 per cent.
This indicates that there could be room for further inward yield movement, especially in those cities where rental growth is expected. But, broadly speaking, secondary locations and second tier cities may provide the best opportunities for income returns in the short to medium term, with investors in Europe potentially having most scope to move up the risk curve seeking future yield compression by targeting these assets.
Rising prices will continue to push yields down but even in high-performing cities the cushion between the risk-weighted return on euro-denominated bonds in Europe and real estate yields makes the latter an attractive prospect in the stronger performing of Europe’s two-speed economies.