Going In Cap Rates and Yield On Cost - Dev Project Question
Hey guys, was looking over a textbook and wanted to clarify this, example below is for a value add project not ground up.
So Yield on Cost would be Year 1 NOI/Costs (Land, Hard, Soft Costs). So if NOI is $10 and Costs are $100 YoC is 10%. From my understanding if the expected exit cap rate is 100 to 200 basis points lower (sell for at least an 8 cap) depending on overall risk developers are generally comfortable with this to move forward with a project.
That seems to be different than a going in cap rate which will only apply to the land (and building on it). So say out of the $100 in total cost 60% of that is land/building. So the NOI of $10 the first year divided by the $60 for land is a 16.6 cap (seems unrealistic but these are made up numbers).
Would this be an example of build to a 16.6 cap and sell for an 8 cap? I am confused because to me this could be seen as build to a 10 (YoC), sell for an 8.
I feel like I am over complicating it and mixing up concepts that are separate.
A couple of points here:
1) Going-in cap rate isn't really a metric used for ground-up development.
2) The assumptions used here aren't what you would see in an efficient market.
Your example is build to a 10 cap but sell for an 8 cap. Which means that you have created about 25% of additional value by building the project as opposed to just buying a similar product for sale in the market. It is also more common to see the going-in cap rate to be lower than exit cap rate in value-add deals since there is "upside" in the deal.
Wouldn't the going in cap rate be higher or you're just saying it's such a low cap rate on little to no cash flow? I would think the cap rate would be high anyway = low purchase price and once you improve it it would be on a more realistic exit cap at a different NOI. Say $1mm NOI on initial existing asset, 10 cap that's $10mm - not sure why it would be a lower cap rate aka higher purchase price up front?
I know in value add and ground up scenarios it's yield on cost compared to exit cap rate and this would play a part into the overall costs as land basis ($10mm for the building aka land if doing ground up) but in any case I'm not seeing the lower going in cap rate.
Some people use the term "Going-in Cap Rate" in different ways. What I was referring to is Cap Rate at purchase price vs. Cap Rate at exit.
For example if you had a value-add multifamily deal with the following deal metrics:
Unrenovated NOI: $1,000,000
Purchase Price: $25,000,000
Renovation Hard/Soft: $5,000,000
Renovated NOI: $2,000,000
Sales Price: $40,000,000
In this case:
Going-in Cap = $1,000,000 / $25,000,000 = 4%
Yield on Cost = $2,000,000 / $30,000,000 = 6.67%
Exit Cap = $2,000,000 / $40,000,000 = 5%
For this particular deal, the spread between the Exit Cap and YoC is 167 bps which would suggest that it's viable
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