In one sentence
A development return metric: stabilized net operating income divided by total project cost.
The longer version
Yield on cost measures the unlevered return a completed, stabilized project produces relative to what it cost to build. Developers and lenders compare it to prevailing cap rates to gauge the value being created.
The gap between yield on cost and the market cap rate is the development spread, a core measure of a project's profitability that lenders scrutinize on construction and value-add deals.
Common questions
- How is yield on cost calculated?
- Divide stabilized net operating income by total project cost. A project costing $20,000,000 producing $1,300,000 of stabilized NOI has a 6.5 percent yield on cost.
- Why do developers and lenders use yield on cost?
- Because it shows the return a project will produce relative to what it costs to build, and whether that return justifies the development risk.
- How does yield on cost relate to cap rates?
- Comparing yield on cost to market cap rates shows the value created. That difference is the development spread.
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