Net Initial Yield vs. Cap Rate What is the actual difference?

I have been talking to various RE Professionals and could not get a clear cut answer/ definition of Cap Rates and Net Initial Yields.

I think many people wrongly think that you can use these terms interchangeably. What is the difference?

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Comments (17)

Sep 23, 2019 - 1:53pm

I have never even heard of net initial yield.. people like sounding smarter than they are by complicating things. Only thing that comes to mind is your adjusted yr 1 cap, or adjusted yr 1 coc.. and by adjusted i mean adjusting for an expected tax burden or increase in opex as you take control year 1 relative to not much increase in the top line... and any debt andpartership costs... something like that.

Sep 23, 2019 - 2:27pm

They may be talking about cash-on-cash returns, which is similar to a return on equity yield.

A cap rate in its simplest form is the going in yield assuming you payed all cash( before depreciation/income taxes). Cash-on-cash is a snapshot of your levered cash flow and what that return is on your equity position.

Sep 23, 2019 - 3:43pm

I assume by "net initial yield" you're talking about return on cost/yield on cost/unlevered yield.

In theory, and as it relates to discussing a deal or doing back of the envelope math, the two are interchangeable.

In practice, due to transaction/closing costs, your basis is going to be a little higher than the price alone, so all else equal, your actual underwritten yield will be slightly below cap rate.

Sep 25, 2019 - 11:06am

No one uses "net initial yield" I've never even heard this before... Proper terms to use are cap-rate (referring to initial NOI/purc. price and sale NOI/sale price), yield-on-cost (refers to NOI/total CapEx at any point in the property lifecycle), and cash-on-cash (or levered net cash flow yield which equals NCFADS/total contributed unreturned project equity contributions).

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Sep 25, 2019 - 11:55am

This is definitely not a industry standard term but you may be talking to someone with finance experience rather than RE specific experience. I think context would be key to understanding what you are talking about.

Based on this info I think you could be referring to two different things:

1) The unlevered yield in year 1 after the tax adjustment. This gets brought up with unsophisticated buyers buying a deal at a 5% cap and then they wonder why they aren't getting a 5% CoC, and its usually because of the Tax bump if the tenant is protected.

2) The levered CoC return in year 1. Which is just the CoC return after debt which comes below NOI and is normally referred to as the Levered Yield or Cash Flow after Debt Service.

Sep 25, 2019 - 12:53pm

I had to google what a net initial yield even is. Looks like it's a cap rate.

Maybe an international term?

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Sep 25, 2019 - 2:17pm

I think you are probably talking spot cap rates (what sale cap rates are today) compared to an untrended yield on cost. A lot of developers look for a certain spread as a general metric to determine if a project makes sense from a risk-adjusted profit margin standpoint. It is essentially a back of the envelope gauge for profit margins.

Sep 25, 2019 - 2:32pm

I've only heard of Pensions/Sovereigns/similar capital using this "metric" in the investment criteria they impose on their operators. It is only relevant really when there are substantial fees going the the operator.

IE: NOI / PP + Closing Costs + AM/CM/Ancillary fees to operator = net initial yield.

At least this is how it was defined in my exp...

Sep 26, 2019 - 4:22am

NIY is very much the term used in Europe, the only time the term 'cap rate' ever gets thrown about over here is when you lovely people fly over and come sit at our table. It is not quite 'cash on cash' as someone mentioned before because it doesn't take into account finance.

NIY is simply; First year net income (ex finance) / Purchase + All add. costs (DD, tax, etc.).

'Yield' is certainly one of the most powerful words you can use in European RE.

Sep 28, 2019 - 4:04pm

Per Green Street:

Net Initial Yield vs. Nominal Cap Rate: While similar, important differences include:
The numerator of the Net Initial Yield calculation is Net Rent, not Net Operating Income. Net Rent is a good proxy for a landlord's cash flow if the property or portfolio concerned is fully leased and if all costs of operating the property are covered by the tenants, but it can overstate cash flow in the case of material vacancy.
Empty Rates (i.e. property taxes) warrant special attention. As a result of an April 2008 tax code change, U.K. landlords now pay full rates on vacant space (after a short grace period). This revision puts U.K. landlords on similar footing to those in the U.S., but the tax rate is much higher in the U.K. than in the U.S. (i.e. 30-40% of Headline Rent in the U.K. and 15% in the U.S.).
The denominator of the Net Initial Yield calculation includes Purchaser's Costs. These total about 5.75% of transaction value and reduce the Net Initial Yield by 30-45 basis points versus the Gross Initial Yield (which does not include Purchaser's Costs). The Nominal Cap Rate calculation does not include Purchaser's Costs in the denominator.

Sep 29, 2019 - 1:14pm

It is often used in Europe. We use NIY and not cap rate when we apply different cap rates to different lines of tenant/surface.
So say I have 4 tenants, on their rent I apply 4.5% cap rate, but on the vacant potential rent I'll apply 6.5%. So the NIY gives me a better idea of what the total cap rate for the investment is.

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May 23, 2021 - 6:52am

NIY is a metric almost only used in Europe. The numerator of NIY is Net Rent (aka passing rent). The denominator for NIY is Purchase Price minus Acquisition Costs/Fees/Taxes. In almost all other parts of the world, cap rate is the go-to metric. The formula is Net Operating Income / Purchase Price.

Another important difference between NIY and Cap Rate, is that NIY most commonly uses Year 0 (aka Last Twelve Months) Net Rental Income, whereas Cap Rate typically takes Year 1 (aka Next Twelve Months) Net Operating Income.

NIY is often regarded as the "lazier" metric because it only shows rental income whereas cap rate also shows how much it costs to operate the asset. However, in Europe it is much harder to acquire data on expenses and therefore NOI, because, quite simply, that's how they've been doing the business for the past hundreds of years. In the U.S. or Asia, which took many of the finance practices from the U.S., expense data and therefore NOI figures on real estate assets are more readily available/reported, and therefore cap rate is universally used in these regions. 

Just as a final note, I've noticed that the comps provided by European brokers/advisors are often adjusted for 100% occupancy. I've never seen such practice in other parts of the world but it seems pretty common in Europe. In America or Asia, occupancy that goes into calculating comps is always based on as-is/actual figures as of the closing date. So, make sure to read the footnotes when you're working on European deals and check if every comps and metrics are apples-to-apples. 

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