Executive Chairman, Fusion Group
We often get asked by investors, 'What kind of yields do you look for?' The answer might sound a little complicated, but the principles are quite easily explained . . . . . As usual, it depends! This post tries to explain the science of it, and tells you where to find the base information.
Yield is a key concept in Real Estate investment. Many institutions like Pension Funds use some of their money to buy property. Why do they buy property? Usually, it’s for the YIELD. Yield is provided by the rents which tenants pay. So, for example, if a Pension Fund buys an office block for $10m, and that office block has a tenant paying $1m per annum rent, the institution is buying a 10% yield. If it is an ‘international’ style rent agreement, it may provide for uplifts in rent every five years – so the institution is buying a rising rent in the future as well. If it had to compete with another fund to buy the property, and ended up paying $12m, the yield it was purchasing would fall to 8.33% In this respect, property is just like the bond market – when prices rise, other things being equal, yields fall (and vice versa).
How do institutions like Pension Funds, or Fusion for that matter, decide what is a reasonable yield? What is a reasonable expectation, and what is unreasonable? There are lots of ways of thinking about this, but the classic approach is to do this:
- Look at what the ‘risk free return’ is, in your market place. The ‘risk free return’ means the rate of return offered on the lowest possible risk instruments in that market – usually, that means Sovereign Bonds or Treasury Bills. This doesn’t mean it is really ‘risk free’ – nothing is risk free! However, it means the lowest risk. Governments are usually considered the lowest risk, because they are big, because they to a certain extent control their own income through the tax system, and because they control the money supply. Not to put too fine a point on it, if they run out of money, they can always go and grab more off taxpayers, or if that fails, print some more!
- This sets a benchmark – you’re not going to want toaccept a yield in Kenya, at a rate lower than the Government pays, are you? Why would anyone do that?? No-one would.
- Then, add a premium to that benchmark, to reflect the risks involved in that particular tenant – known as his COVENANT. For example, a very high quality corporate tenant, who is almost as good as the Government in terms of credit quality (but can’t print its own money, or collect revenues with the force of the state behind it!) might expect to pay 1% or 2% (‘100 basis points or 200 basis points’ as it is sometimes described) over what the Government pays. At the other extreme, a small business with shaky revenues and not much security to offer might have to pay 10% (1000 basis points) over the Government rate.
Get yourself a copy of Fusion’s Africa Real Estate Report – and look at the yield statistics for each of our countries printed there. Additionally, Fusion monitors return rates across Sub Saharan Africa, to make sure we are making the best returns for our investors. Have a look at Fusion African Monitor at https://www.fusioncapitalafrica.com//media-centre/fusion-monitor/ to see what returns are offered in different African countries.