One line of arithmetic, five defensible-looking answers between 5.20 and 6.50 per cent, and only one of them is rent the owner will bank.
The reversionary yield is the estimated rental value (ERV), less non-recoverable costs, divided by the price including purchaser's costs: it is the yield the building would show if every lease were reset to market rent today. On an illustrative 10,000 m² office bought for 40,000,000 plus 6.8 per cent costs, with 2,200,000 of passing rent, an ERV of 2,600,000 and 120,000 of non-recoverables, the net initial yield is 4.87 per cent and the reversionary yield 5.81 per cent. Measured on the net effective ERV after a year's rent-free, it is 5.20.
Worked in full in Office Real Estate by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
The two yields together tell you whether a building is under-rented or over-rented and by how much. Neither tells you when the reversion arrives or what it costs to capture, and that is why the reversionary yield on an office is so often quoted at a figure the owner never banks. The calculation is one line; the inputs are where it goes wrong.
| Input | Value |
|---|---|
| Net internal area, m² | 10,000 |
| Net price | 40,000,000 |
| Purchaser's costs | 6.8% |
| Gross price, including costs | 42,720,000 |
| Passing rent a year (220 per m²) | 2,200,000 |
| ERV, headline (260 per m²) | 2,600,000 |
| Non-recoverable costs a year | 120,000 |
| Rent-free on a new ten-year letting, months | 12 |
Net initial yield = (passing rent − non-recoverables) ÷ (price × (1 + costs))
Reversionary yield = (ERV − non-recoverables) ÷ (price × (1 + costs))
In Excel: =(ERV-NonRec)/(Price*(1+Costs)). Keep the denominator identical to the one in the net initial yield, or the gap between the two yields means nothing.
| Line | Net income | Yield on 42,720,000 |
|---|---|---|
| Passing rent less non-recoverables | 2,080,000 | 4.87% |
| Headline ERV less non-recoverables | 2,480,000 | 5.81% |
| Reversion | 400,000 | 0.94 points |
The building is under-rented by 18.2 per cent, and the reversion of 400,000 a year adds 94 basis points to the yield, if it is captured at headline and without cost.
Office ERVs are usually quoted as headline rents, and headline rents in most office markets are paid only after a rent-free period. A new ten-year letting at 260 with twelve months rent-free pays, spread straight-line over the term without discounting, 234 per m². Applied to the building, that is a net effective ERV of 2,340,000 and a reversionary yield of 5.20 per cent, not 5.81. Most of the apparent reversion was incentive.
| Version | Yield |
|---|---|
| Headline ERV, net of non-recoverables, on price with costs | 5.81% |
| Same, on the net price without costs | 6.20% |
| Headline ERV, non-recoverables ignored, price with costs | 6.09% |
| Both errors together | 6.50% |
| Net effective ERV, net of non-recoverables, price with costs | 5.20% |
The spread from 5.20 to 6.50 per cent is 130 basis points on the same building and the same price. Each version can be found in a sale brochure; only the last row is a figure an owner can expect to collect, and even it ignores the void and the fit-out between leases.
| ERV per m² | ERV | Reversionary yield | Gap to NIY, bp | Status |
|---|---|---|---|---|
| 200 | 2,000,000 | 4.40% | −47 | Over-rented |
| 220 | 2,200,000 | 4.87% | 0 | Rack-rented |
| 240 | 2,400,000 | 5.34% | +47 | Under-rented |
| 260 | 2,600,000 | 5.81% | +94 | Under-rented |
| 280 | 2,800,000 | 6.27% | +140 | Under-rented |
Every 20 per m² of ERV moves the reversionary yield by about 47 basis points, so the ERV deserves more evidence than any other input. Price works the other way: at 36,000,000 the yields are 5.41 and 6.45 per cent, at 44,000,000 they are 4.43 and 5.28. To reach a 6.0 per cent reversionary yield on the headline ERV, a buyer can pay at most 38,701,623 net; to reach 5.5 per cent, 42,219,952.
When the ERV is below the passing rent the reversionary yield is below the initial yield. An over-rented office loses income at each expiry, and a high initial yield on it is a warning, not a bargain.
Reversionary yield = (ERV − non-recoverables) ÷ price including costs: 5.81 per cent here on the headline ERV, 5.20 on the rent actually banked, against a 4.87 per cent initial yield. Compute it on net effective rent and the same denominator as the initial yield. The book's three yields for one office, quoted, reversionary and capital-adjusted, sit side by side in the free workbook for this case. Timing is solved in how to calculate the equivalent yield, and the cost of the re-letting cycle in how to compute a capital-adjusted yield on an office.
Both divide net income by the price including costs; the initial yield uses the rent passing today and the reversionary yield the estimated rental value. On an illustrative office at a 42,720,000 gross price they are 4.87 and 5.81 per cent, a 94 basis point gap that says the building is under-rented by 18.2 per cent.
Yes, when the building is over-rented, meaning the passing rent exceeds today's rental value. On an illustrative office with an initial yield of 4.87 per cent, an ERV of 200 per m² against 220 passing gives a reversionary yield of 4.40 per cent: income falls at each lease expiry.
Net effective, because that is the rent an owner banks after incentives. On an illustrative office a headline ERV of 260 per m² with twelve months rent-free on a ten-year term is 234 net effective, and the reversionary yield falls from 5.81 to 5.20 per cent.
This article is one calculation from Office Real Estate. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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