Are you guys including capitalized interest into the calculation for YOC?
I calculate YOC as NOI/TDC. My TDC includes land, construction costs, soft costs, dev acq fee, and contingency. I do not include capitalized interest as I consider YOC to be an unlevered metric.
Curious to hear your thoughts. Also, what are you guys seeing on dev acq fees (currently assuming 5% of land cost)?
Based on the most helpful WSO content, your approach aligns with the general consensus that Yield on Cost (YOC) is typically considered an unlevered metric. YOC is calculated as NOI / TDC, where TDC (Total Development Cost) includes land, construction costs, soft costs, development acquisition fees, and contingency. Capitalized interest is generally excluded from TDC in this calculation because it is a financing cost, and YOC is meant to reflect the project's performance without the influence of leverage.
Regarding development acquisition fees, assuming 5% of land cost is within a reasonable range. However, the exact percentage can vary depending on the market, deal structure, and developer. Some developers may adjust this percentage based on the complexity or risk profile of the project.
Sources: Yield on Development Costs, Developers - How do you calculate how much to pay for land to develop a rental property?, Q&A:New Real Estate Development Shop, Great Deals You've Recently Done, What to look for in a Development Budget?
you can do either. usually have the total costs incl financing
I include cap interest in TDC. yield on cost is an unlevered metric yes but the use of YOC is to compare to what cap rates properties are selling for
yeah unfortunately i would have to agree that interest reserve goes into TDC. if your carry costs and financing costs are so fucking high that your YOC is 5% and the going cap rate is 5, but your unlevered YOC is 7, then you'll wish you had included capitalized interest and financing costs in your TDC for calculating YOC....
Only exception would be if you're actually considering building the project all cash.
I've gone both ways on this with LPs. I think that the general rule here is to include the interest reserve into the YoC calculation. However, I argue that the interest reserve is more indicative of the capital behind the project than the merit of the project itself (although the project profile also plays a role).
Let's assume a project has a $1MM NOI, costs $16.67MM to build, and stabilizes to a $20MM value.
Here are 3 scenarios that I've though about:
In Scenario 1, the project seems to pencil. In Scenario 2, most people would argue that the project is not viable. In Scenario 3, the project doesn't pencil particularly well but is viable. High level IRRs are about 10, 12% and 17% respectively.
In my personal opinion, I don't think that financing costs should be included in YoC because they can heavily distort the perception of a project's viability. However, internally, knowing your sponsorship strength and means, the metric can have weight.
Wouldn't that suppport including financing costs in YOC? Unless you're actually planning on building all cash. Scenario 1 makes it look like you have a decent spread over exit (you're creating 20% of value) but thats not actually true if you plan to use debt.
I think I'd agree with you. Reasonably speaking, development requires debt, so the cost of that debt should be taken into account when determining viability
Well no because debt terms and options are largely driven by sponsorship. My whole point was that if you included debt into the equation, you're largely weighing sponsorship strength/financial capacity as opposed to the merits of the project alone.
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