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Cap rates don’t tell the full story.

When underwriting a multifamily property, most investors are less concerned about cap rates and more interested in the yield on cost.

This is especially true for value-add and development deals.

Yield on cost is an underrated financial metric that can give great insights into a commercial real estate investment. To verify that the risk incurred is worth the return on investment, evaluate the yield on cost.

What is Yield on Cost?

Yield on cost is the net operating income (NOI) at stabilization divided by the total project cost. Yield on Cost is often used interchangeably with Return on Cost (ROC), Development Yield, and Net Yield.

Yield on Cost= Net Operating Income/Total Project Cost

The Problem With Relying on Cap Rates:

Cap rates look at how quickly you are earning back your investment on an unlevered basis.

The cap rate formula is misleading because it doesn’t account for the CapEx amount. CapEx or capital expenditures is the cost for the needed improvements to the property.

While an investment may look like a reasonable cap rate (high) at the surface level, if other comparable properties trade around the same cap rate but don’t need a significant CapEx budget, the property may be overvalued.

Simply put, if you know you are buying a property that needs a significant amount of work completed, you will want to buy at a price that makes sense based on the amount of work it will take to stabilize it.

• Multifamily National Report-February 2024

• Zillow: 2024 Rental Market Report

• CBRE Cap Rate Survey Suggests That the Market is Finding a Floor

• Asking Rents Climb 2% in February, Biggest Gain in Over a Year

• Multifamily Permitting Falls 9% in January

• How new apartments create opportunities for all

• Apartment List Renter Migration Report: 2024

📈 Chart of The Week

Sun Belt Markets Dominate 2024 Employment Forecast. Austin is expected to record the fastest job growth in the nation among major markets, according to data from RealPage

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