Yield on Cost: What goes in the denominator?
Hey folks,
Conceptual question: when you calculate Yield on Cost in CRE models, what exactly do you include in the cost base?
Specifically:
- Asset cost only (purchase price, acquisition costs, hard/soft capex, leasing costs/TI/LC) — to keep it comparable with market NIYs?
- Or total funded cost including capitalized interest and loan fees — to reflect true all-in cost of capital?
What about partial interest coverage from rental income? In many CRE deals, operating NOI partially (or fully) covers the loan interest — i.e. only the uncovered portion of interest gets capitalized to the loan balance. In that case, do you:
- Net the covered interest out of the YoC cost base (since it's effectively "self-funded" by the asset and not a real equity drain)?
- Still include the full capitalized + cash-paid interest in the cost base?
- Or use the same convention regardless asset-only YoC, treating all financing costs separately?
Curious whether your firm has a clean rule, or whether it's case-by-case depending on how meaningful the rental coverage is?
Thank you very much
When calculating Yield on Cost (YoC) in CRE models, the denominator typically includes total development costs. Based on the most helpful WSO content, here's how the components are generally treated:
Asset Cost Base: This includes the purchase price, acquisition costs, hard and soft capex, and leasing costs (TI/LC). These are standard inclusions to reflect the direct costs of creating the asset.
Capitalized Interest and Loan Fees: Many firms include these in the cost base to reflect the true all-in cost of capital. This approach provides a more comprehensive view of the total investment required to stabilize the asset.
Partial Interest Coverage from Rental Income:
Case-by-Case Adjustments: While some firms have a clean rule, others adjust based on the materiality of rental coverage. For example, if rental income significantly offsets interest costs, firms might exclude the covered portion to avoid overstating the cost base.
Ultimately, the approach depends on the firm's preference for comparability (e.g., aligning with market NIYs) versus reflecting the true all-in cost of capital.
Sources: Great Deals You've Recently Done, REPE Interview Question: Evaluating whether to carry out CapEx?, What to look for in a Development Budget?, WSO Exclusive: Legerdemath - Anatomy of a Banking Trick
There is absolutely zero concesus here. I do a rolling yield on cost. So all capex, fees, etc.
some people just add negative cash flow to their basis. If cash flow covers fees and capex, it doesn’t get counted.
So my yield on cost is lower then method two. But as long as you look at every deal the same, you begin to see the patterns of what works for you.
General rule at my shop is to include all asset related costs, financing fees, and interest not paid by NOI. Also if NOI can cover any capex we would still include that capex in the basis.
all-in costs (including financing costs, even if PIK'd) until the date of peak equity, net of any revenues / positive cash flows
We add all the costs for our untrended YOC calcs - assuming you're calculating a ground up deal, we do everything (deficit in NOI, costs related to closing/capitalized interest, etc).
There's also a case of trended YOC - do you add in rent growth, add in escalation on hard costs, etc. We stick with untrended ROC for a more accurate calc of qhat we can build to.
My firm calculates our rolling cost basis as the sum of acq costs, closing costs, dev costs, capex, TI's, leasing commissions, financing costs, interest reserve, and operating carry.
Interesting to see how different shops handle this — the “rolling cost basis” approach mentioned above is pretty close to what I’ve seen in practice as well.
One thing that’s helped in our models is separating decision metrics vs reporting metrics. For internal underwriting, we usually lean toward an all-in YoC (including financing drag, interest reserve, etc.), especially up to peak equity. But for benchmarking against the market, we’ll often strip it back to asset-level costs so we’re not mixing capital structure with asset performance.
On the NOI covering interest point — most teams I’ve worked with avoid dynamically netting it out, mainly because it creates inconsistency across deals. Instead, they either:
Consistency > precision in this case.
I've posted about this in the past so you could see my position on this subject matter. YoC is usually compared to the cap rate to figure out how much of a premium that you're able to get by building vs buying. By that logic, trending makes little sense since existing assets would most likely follow the same trend.
Including financing fees also doesn't make too much sense since it becomes sponsor and strategy specific. For example, if you built the deal entirely with cash, in theory you would have the lowest returns but the highest YoC vs levering up the deal to a point that's accretive. In theory if you could find 90% leverage, a 50bp all-in YoC premium to cap rate could be a homerun deal from an IRR standpoint.
I think what @harryjames is saying makes a ton of sense. If you're pursuing similar financing structures across all deals, it could make sense to assess the all-in YoC internally as a way to compare projects. But personally, I find that most people discussing YoC are referring to the all-in YoC instead of excluding the financing which I think is much less useful.
Edit: I plugged this argument into AI and it brought up a good point that I wasn't considering. If you're evaluating from a risk perspective, all-in YoC makes more sense as a metric. Basically it can tell you how much the cap rate can move before your project is underwater. However, I still stand by my case that the all-in YoC should be an internal metric because it heavily hinges on financing while the un-leveraged YoC is a better metric to assess feasibility.
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