What yield on cost measures
Yield on cost answers the developer's question: what return does the finished project earn on every dollar spent to build or reposition it? $800,000 of stabilized NOI on a $10,000,000 all-in cost is an 8% yield on cost. It is the development equivalent of a cap rate, with cost in the denominator instead of value.
The spread between yield on cost and the market cap rate is the development margin. If comparable stabilized assets trade at a 6% cap rate, the 8% yield-on-cost project would be worth about $13,300,000 on completion, a gain of roughly $3,300,000 over cost before transaction costs.
How lenders and investors read it
Construction and bridge lenders look at yield on cost alongside LTC because it tells them whether the project creates enough value to be refinanced or sold at a profit. A thin spread over market cap rates leaves little room for cost overruns, slower leasing, or a rise in exit cap rates.
Equity investors compare untrended yield on cost (today's rents) with trended yield on cost (rents grown through the construction period). Underwriting that only works on trended figures is carrying more risk than the headline suggests.
Limitations
The measure depends on two forecasts, stabilized NOI and total cost, and both tend to move against the developer. Use conservative rents, full contingency, and all financing costs, and test the result at a higher exit cap rate before relying on the spread.
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