What yields should investors consider in commercial property now that interest rates are higher?

The current inflated interest rate is a challenging time for investing in commercial property. It can be difficult to maximise and maintain yields in an environment where borrowing costs are high, property values are decreasing, and the market landscape is changing. It is important to consider your investment strategy and understand the potential risks and rewards.

When interest rates are high, look for opportunities for higher yields and long-term growth. Here are a few considerations.

Get the fundamentals right

Yields above 6 per cent with the right fundamentals, such as rental growth, capital growth, short supply, long lease and good location can be considered good yields because they offer a higher return on investment.

A yield above 6 per cent indicates the property has the potential to provide a higher level of income and capital appreciation over time.

However, while a yield above 6 per cent can be considered good, you should also consider other factors such as market conditions, tenant quality, property condition and potential risks before making an informed investment decision.

Return on your investment

In recent times, fast food assets, service stations and childcare centres have sold well below the 5 per cent yield range — some in the high 3 per cent range. This is an example of a poor investment as there is no chance of a good return on your equity. Even with strong rental growth, you’re starting from such a low base point, it would be hard to get ahead.

Smart investors wouldn’t choose this path, but some investors simply do not care about returns as they are just looking to hold money in a low-risk or low-return financial medium until a better investment opportunity arises. This is not the work of a true investor. So, what should you be looking for?

Rental income

Rental income is an important yield because it is a stable source of income. However, in a high interest rate environment, tenants may be less willing or able to pay higher rents, which can reduce the rental income generated by the property and can lower the yield on your investment.

Rental yield can be used to compare the return on investment between different properties before you invest, helping you to make an informed decision. A high rental yield means the property is generating a high income compared to its cost, which suggests it has potential for generating profit.

Loan repayments

With every interest rate hike comes higher loan repayments and a drop in discretionary income. If you want to steady your cash flow, you will need an investment with a higher yield than the interest rate of your loan to ensure you generate enough income to cover your loan payments and still have a positive cash flow.

While higher repayments may reduce affordability, higher rates also reduce the amount you can borrow and the value of your commercial investment. All these factors can lead to an increased risk of loan defaults or strained refinance opportunities so having an emergency fund that can cover at least three to six months of living expenses can help you ride out the highs and lows of such hikes.

Market risk

Our average yield in recent times has been between 6 per cent and 8 per cent. There is obviously more risk with investments in the 8 per cent yield range such as shorter leases, older buildings or regional locations.

Market risk is also a consideration because the value of your investment will fluctuate based on changes in interest rates, inflation and economic factors. If the market conditions change, the value of your investment may decrease, resulting in a loss of principal; however, as all investors have a different brief, it’s important to weigh up the options when considering an opportunity.

Economic conditions can change quickly and yields that appear attractive in one interest rate environment may not be as profitable in another. By considering a variety of yields, investors can be more adaptable to changing market conditions and adjust their investments accordingly to maintain a positive cash flow when interest rates are high.