Rent paid on the quarter days, in advance, earns more than the yield a valuer quotes. Here is the conversion, and what it is worth in a bid.
A nominal yield assumes rent arrives once a year in arrears; a true yield reflects rent paid quarterly in advance. The conversion is true yield = (1 ÷ (1 − nominal ÷ 4))4 − 1, so a property bought at a 5.00 per cent nominal yield actually returns 5.16 per cent. The 16.0 basis points are real money: price the same building at a true 5.00 per cent and it is worth about 3.11 per cent more.
Worked in full in Commercial Real Estate Investing by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Valuers quote yields as rent divided by price. That ratio is a convention, and it carries a hidden timing assumption: the whole year's rent is treated as one payment received at the end of the year. Most commercial leases do the opposite. Rent is paid in four instalments on the quarter days, each one at the start of the quarter it covers. The landlord holds the money earlier, so the investment earns more than the headline ratio says.
The difference does not matter when two valuers compare initial yields with each other, because both sides use the same convention. It matters the moment a yield is set beside anything computed on actual cash-flow timing: a discounted cash flow, an IRR target, a bond yield, a cost of debt. That is where the true yield is needed.
| Input | Figure |
|---|---|
| Rent, net of non-recoverable costs | $1,200,000 a year |
| Payment pattern | $300,000 a quarter, in advance |
| Price paid (before purchaser's costs, for simplicity) | $24,000,000 |
| Nominal yield, rent ÷ price | 5.00% |
Start from what the buyer actually receives: $300,000 today and $300,000 at the start of every following quarter, in perpetuity on the valuer's simplification. The present value of that stream at a quarterly rate i is the quarterly rent multiplied by (1 + i) ÷ i. Set it equal to the price and solve.
Rearranging the perpetuity in advance gives i = (nominal ÷ 4) ÷ (1 − nominal ÷ 4).
(0.05 ÷ 4) ÷ (1 − 0.05 ÷ 4) = 0.0125 ÷ 0.9875 = 1.2658 per cent a quarter.
(1 + 0.012658)4 − 1 = 5.1602 per cent, which rounds to 5.16 per cent.
=(1/(1-B1/4))^4-1 with the nominal yield in B1. For monthly rent in advance, replace both 4s with 12.
Discount $300,000 a quarter in advance at the quarterly equivalent of 5.1602 per cent: the present value is $24,000,000 to the dollar.
The true yield is 16.0 basis points above the nominal one. Nothing about the building, the tenant or the price has changed. The extra return is purely the value of being paid three months early, every quarter.
Now turn it round. Suppose a buyer's investment committee sets its required return as a true 5.00 per cent, on actual cash-flow timing, because that is how its cost of capital and its DCF are built. What can it pay for the same $1,200,000 of quarterly-in-advance rent?
| Basis | Rate used | Years' purchase | Value |
|---|---|---|---|
| Nominal 5.00%, annual in arrears | 5.00% | 20.00 | $24,000,000 |
| True 5.00%, quarterly in advance | 1.227% a quarter | 20.62 | $24,745,426 |
| Difference | $745,426 |
A bidder who prices on a true basis can pay $745,426 more than one who applies the same 5.00 per cent as a nominal yield, and still earn exactly its target. In a competitive sale that is the difference between winning and coming second. Quoted back in market language, the winning bid is a 4.85 per cent nominal yield.
The conversion is not a fixed add-on. It widens as yields rise, because the value of receiving cash early grows with the rate at which it can be reinvested.
| Nominal yield | True, quarterly in advance | Gap (bp) | True, monthly in advance | Gap (bp) |
|---|---|---|---|---|
| 4.00% | 4.10% | 10.2 | 4.09% | 8.8 |
| 5.00% | 5.16% | 16.0 | 5.14% | 13.8 |
| 6.00% | 6.23% | 23.2 | 6.20% | 20.0 |
| 7.00% | 7.32% | 31.7 | 7.27% | 27.3 |
| 8.00% | 8.42% | 41.7 | 8.36% | 35.8 |
Two things stand out. At secondary yields of 7.00 to 8.00 per cent the gap reaches 31.7 to 41.7 basis points, which is the size of a typical market move. And monthly rent in advance, common in residential and some multi-let schemes, is worth slightly less than quarterly in advance at the same nominal yield. That looks wrong until you lay the dates side by side: quarterly in advance pays the second and third months of every quarter one and two months before monthly in advance would.
The usual error is to compound the nominal yield as if the rent were paid quarterly in arrears: (1 + 0.05 ÷ 4)4 − 1 = 5.09 per cent. That understates the true yield by 6.6 basis points, because it ignores that each instalment arrives at the start of the quarter, not the end. The formula needs the “1 minus” in the denominator.
The second error is the mirror image and costs more. An analyst builds a quarterly DCF that returns 5.16 per cent, then capitalises the rent at that figure as if it were a nominal yield. $1,200,000 ÷ 5.1602 per cent is $23,254,717, which undervalues the asset by $745,283, or 3.11 per cent. Yields and discount rates must be on the same timing basis before they are compared. The equivalent yield and the net initial yield with purchaser's costs both carry the same convention, so the same conversion applies to them.
Rule of thumb: at yields between 4 and 8 per cent, the quarterly-in-advance uplift is roughly the nominal yield squared, multiplied by 0.64 to 0.65. Use the formula for anything going to committee.
A quoted yield is a ratio, not a return. When the rent is paid quarterly in advance, convert it with (1 ÷ (1 − y ÷ 4))4 − 1 before setting it beside an IRR, a cost of capital or a debt rate. At 5.00 per cent the true figure is 5.16 per cent; at 8.00 per cent it is 8.42 per cent. The book's own sale is priced on a stabilised income over a gross value, and the free workbook for this case shows how a few basis points of exit yield move the equity return, which is why the basis of the yield has to be settled first.
A nominal yield treats a year's rent as one payment at the end of the year. A true yield reflects the actual timing, usually quarterly in advance. Because the landlord is paid earlier, the true yield is higher: 5.16 per cent against a 5.00 per cent nominal yield, and 8.42 per cent against 8.00 per cent at a secondary pricing level.
No, slightly less at the same nominal yield. Monthly in advance converts a 5.00 per cent nominal yield to 5.14 per cent, against 5.16 per cent for quarterly in advance. Quarterly in advance pays the second and third months of each quarter one and two months earlier than a monthly schedule would, so the landlord holds the cash longer.
That formula assumes quarterly payments in arrears. Rent paid in advance needs (1/(1 - y/4))^4 - 1. At a 5.00 per cent nominal yield the arrears formula gives 5.09 per cent, understating the true yield of 5.16 per cent by 6.6 basis points.
This article is one calculation from Commercial Real Estate Investing. 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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