A.CRE

Yield-on-Cost

Yield-on-cost is the net operating income (or sometimes cash flow from operations) at stabilization divided by the total project cost, whereas the capitalization rate (cap rate) is the stabilized net operating income (or sometimes cash flow from operations) divided by the market value of the property.

Net Operating Income at Stabilization ÷ Project Cost

The net operating income at stabilization may be calculated with (trended) or without (untrended) income and expense grow assumptions.

The yield-on-cost serves to help the real estate investor calculate the difference between the market yield and the actual yield of an investment. In development, this difference between market yield (market cap rate) and actual yield (yield-on-cost) is called the development spread.

Putting ‘Yield-on-Cost’ in Context

For a practical application of Yield-on-Cost, consider the hypothetical “Eastside Industrial Hub,” a value-add industrial project located in Charlotte, North Carolina. This project, undertaken by Titan Industrial Partners, involves the acquisition and renovation of an aging 250,000 square foot industrial facility, transforming it into a state-of-the-art distribution center.

  • Location: Charlotte, North Carolina
  • Project Name: Eastside Industrial Hub
  • Developer: Titan Industrial Partners
  • Total Project Cost: $35 million
  • Facility Size: 250,000 square feet

Titan Industrial Partners purchased the facility for $20 million and budgeted an additional $15 million for extensive renovations, including structural upgrades and modern logistical support systems. Upon completion, the anticipated untrended Net Operating Income (NOI) at stabilization is projected to be $2.8 million annually. Calculating the untrended Yield-on-Cost:

  • Yield-on-Cost = NOI at Stabilization ÷ Total Project Cost = $2.8 million ÷ $35 million = 8%

This yield illustrates how much return the project generates on the actual dollars spent. The 8% untrended yield-on-cost, compared to the prevailing market cap rate of 7% for similar industrial properties in the area, indicates an untrended development spread (i.e. investment spread) of 1%.

Frequently Asked Questions about Yield-on-Cost in Commercial Real Estate

Yield-on-cost is the net operating income (NOI) at stabilization divided by the total project cost. It helps investors understand the return on actual dollars spent in a real estate development or renovation project.

Yield-on-Cost = Net Operating Income at Stabilization ÷ Total Project Cost. For example, if the NOI is $2.8 million and the total cost is $35 million, then the yield-on-cost is 8%.

Yield-on-cost uses total project cost in the denominator, while cap rate uses the market value of the property. Cap rate = NOI ÷ Market Value, whereas yield-on-cost = NOI ÷ Project Cost.

The development spread is the difference between the yield-on-cost and the market cap rate. In the Eastside Industrial Hub example, the yield-on-cost is 8% and the market cap rate is 7%, resulting in a 1% spread.

Yield-on-cost may use trended (includes future income/expense growth) or untrended (static assumptions) NOI at stabilization. The example given uses untrended NOI of $2.8 million.

An 8% yield-on-cost means the project is expected to generate an 8% return on the total dollars invested. If market cap rates are lower (e.g., 7%), it suggests the project is creating value above market expectations.

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