High Income Yields, Predictable Income Growth
Investment grade commercial property offers investors relatively high income yields, together with long term capital appreciation. This positions the asset class between equities and bonds in terms of volatility and risk-adjusted total returns and justifies its inclusion in investment portfolios. Property earnings are generally underpinned by contractually binding lease agreements and, due to entrenched rental escalation rates contained in those leases, the predictability of steady income growth over time sets property apart from other fixed interest assets such as bonds.
Property yields are influenced largely by the movement in the risk-free bond yield as well as by the risk associated in the underlying income streams and the anticipated growth therein, factors which are informed by the state of the general economic environment as well as specific tenant performance. Given the differing influences on income yields and capital appreciation, which vary constantly through economic cycles, it is important to view an investment in property in terms of the total return that should be expected - both from an income yield as well as the appreciation in value that will accrue over time.
The predictability of the property income return brings greater certainty to the underlying asset value and the performance of financial markets in the last decade has demonstrated that an asset with a secure and certain income stream will maintain value through varying investment cycles.
By virtue of the relatively high income yield that property generates, these investments lend themselves to effective gearing strategies, which offer the investor higher capital growth over time, albeit at increased risk levels. Depending on the investor's propensity for risk, property investments can be structured so as to match the rental income with the cost of debt and, in so doing, reduce the initial income yield almost entirely in the expectation of a higher return on equity.
Given the relevance of the income return derived from a property investment, the timing of an acquisition is significant so as not to overpay for future cash flows. Equally, fairly priced, ungeared property assets will both underpin the income requirements of an investor, especially retired investors, and provide a long term capital hedge against the impact of inflation.