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. 

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Comments (2)

May 12, 2022 - 12:56pm
CRESEA, what's your opinion? Comment below:

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. 

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May 12, 2022 - 1:47pm
CREnadian, what's your opinion? Comment below:

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