Yield on Cost
Also called: YOC, Development yield, Stabilized yield on cost
Yield on cost is stabilized net operating income divided by total project cost including acquisition and capital expenditures, measuring the unlevered yield a business plan produces once complete.
Yield on cost is the value-add and development equivalent of a cap rate. Cap rate prices the deal as it exists today. Yield on cost prices the deal as it will exist after you spend the renovation budget and lease it up.
The spread between yield on cost and the prevailing market cap rate is the development spread, and it is the cleanest single measure of whether a business plan creates value. If you can build or renovate to a 6.5% yield on cost in a market that trades at 5.5%, you have manufactured 100 basis points of spread, which capitalizes into equity.
How to calculate yield on cost
Yield on Cost = Stabilized NOI / (Purchase Price + Capital Expenditures + Closing and Carry Costs)Worked example
A value-add acquisition with a unit renovation program:
- Purchase price
- $6,000,000
- Renovation and capital budget
- $960,000
- Closing and carry costs
- $240,000
- Stabilized net operating income
- $505,000
Rules of thumb
- A development spread of 100 to 150 basis points over market cap rate is the common threshold for a value-add plan being worth the execution risk.
- If yield on cost is below the going-in cap rate, the capital plan is destroying value and should be re-scoped.
Related terms
- Capitalization Rate (Cap Rate)
A capitalization rate is a property's net operating income divided by its purchase price, expressed as a percentage, and it represents the unlevered annual yield the property produces at that price.
- Value-Add
Value-add is an investment strategy that acquires a property with identifiable operational or physical upside and invests capital to raise its net operating income, increasing value beyond market appreciation.
- Net Operating Income (NOI)
Net operating income is a property's effective gross income minus all operating expenses, excluding debt service, capital expenditures, depreciation, and income taxes.