Hurdle Rate

What is a hurdle rate, and what connection does it have to RE investments? What rate is acceptable? How feasible is a 7% return today?

Simply put, a hurdle rate is the required percent return of an investor that would make him pursue an investment. For RE assets, investors use its (gross) rental yield to determine if it meets their hurdle rate.

What's rate is acceptable?

Some investors may use the average return of the stock market or their business's gross profit margin as hurdle rates. This isn't ideal because these investments entail different risks from RE. The bigger the risk of an investment, the higher the potential return.

Some investors would typically state hurdle rates of ~7%. They likely derived this percentage from the rental income of their other properties in their portfolio.

How feasible is a 7% return today?

With the rapid increase in RE prices, finding a property with such a return is not easy. Consider a condo unit selling for P300K /sqm. To attain a 7% return, the asset should be leased at P1,750/sqm/month–a steep amount even for the country's most luxurious condos (the average rental rate in BGC post-pandemic is P800/sqm).

Put another way, a property with a potential rent of P800/sqm must be bought at P137K/sqm to hit the 7% hurdle rate. Determining a buyer's maximum budget when purchasing a property is another beneficial way to use hurdle rates.

Some Quezon City (QC) properties have rental rates of ~9%. These are the properties selling for P2 Mn that could be rented out for Php15,000/month.

Should investors always choose investments with higher returns? For example, should they choose a QC condo with a 9% rental yield over a condo in the BGC with ~4%?

Not necessarily. Another factor to consider (on top of rental yield) is a property's projected capital appreciation (CapApp). When an investor sells the asset in the future, the gain from selling it is over and above a property's rental income, boosting the overall return to hit the targeted hurdle rate. (CapApp is another lengthy topic, so I'll save it for another post.)

In summary, hurdle rate is one metric used by investors to determine whether or not a property is a good buy.

Disclaimer: Some may find my explanation overly simplistic. I deliberately did this to make the post more palatable to everyone.