Ground up development- Return on Cost

I've got a question on the Return on Cost Ratio:
We've got an unusual cap stack for our ground up developments - 55% GP, 45% LP equity split with 75% construction loan.
Our GP equity is made up of cash, plans/entitlements, etc. and accounts for roughly $2.5M in our cap table. I'm looking for an accurate return on cost to provide to a PE group and am wondering if our GP equity should be fully included in the ratio as a function of the cost. Appreciate the help.

 
Most Helpful

Return on cost = NOI divided by Total Project Cost. Say you expect a development to generate $7MM in NOI but it will cost $100MM to complete it, your return on cost would be 7%.

You are confusing concepts here because how you split up equity contributions will not influence this ratio - say you borrow $65MM from a bank, that leaves $35MM in equity. Whether you split this 90-10% or 45-55% between partners, this will not change the deal’s return on cost (since it doesn’t change NOI or Project Costs).

Now a slight nuance to this is that if you happen to start changing how much you can/do borrow as a loan it would have an effect on the return on cost (also known as development yield) since Total Project Costs includes financing costs and interest. More debt = more interest expense = higher project cost = lower development yield.

 

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