What yields are everyone seeing when it comes to development costs? Mainly interested in multifamily. We all know that developers make their money on the spread between yield on development costs and selling cap rate.
However, I have heard conflicting reports that the spread is almost non existent or it is still a 200-300 bps. Any MF developers out there? Just curious to know if it is even worth it to develop MF at this point in the cycle.
| +82 | LP coming into deal at higher land basis. How to model returns to GP? | 18 | 13h | |
| +76 | Increasing RE Industry's Cash Compensation, Collectively | 43 | 13h | |
| +72 | Major Decisions | 13 | 1d | |
| +28 | Niche down to an operator or stay an allocator | 9 | 3d | |
| +24 | Breaking into CRE late 20s | 7 | 4d | |
| +23 | Thoughts on joining an early-stage REPE fund | 7 | 11h | |
| +22 | Self Storage ECRI | 9 | 2d | |
| +20 | Doom Loop or Creative Urban Reemergence? | 3 | 6d | |
| +19 | How to get good at RE Modelling? | 16 | 3h | |
| +18 | 3 Hour Condo/Rental Excel Test - What Can Be Expected | 2 | 4d |
Career Resources
Get instant access to lessons taught by experienced private equity pros and bulge bracket investment bankers including financial statement modeling, DCF, M&A, LBO, Comps and Excel Modeling.
Not in MF but curious to hear responses for that asset type. In the industrial space, we look for a 7-8% YOC and a minimum 200 bps spread to exit cap. We are getting them, but the biggest spreads are coming from land we have a good basis in because we bought it 2 years ago. However, I am noticing many development being sold as forwards now. To add, isn't the equity multiple much more on the smaller cap rates? Wouldn't mind hearing input on this too. The biggest problem for us in our budgets are construction costs spiraling out of control. I know lots of guys on the construction side getting as fat as they can while its good.
where are you guys developing to a 7-8 in industrial?
And to OP I'm not in multifamily, but aren't yields pretty tight in the space (at lease in very developed markets) - typically 100 - 150 bps?
That's insane. Our industrial team is underwiting deals at 50bps above the exit to get their foot in the door on RFPs. Last I heard from them, they made it sound like that's pretty common these days for high-credit BTS deals.
On the sr side we underwrite to 150bps above the exit. We are extremely conservative on our operating, lease up, and exit cap assumptions. Based on what we've heard from the market on exit caps we think our current deals will sell around 200-250bps above the exit.
Granted, we are a union shop and are known to be somewhat expensive.
We are seeing spreads of 175 bps+ on multifamily right now. BTS type projects are much thinner and are coming in around 75-125 bps.
Depends which market. Spreads are very tight.
We typically look for 125 bps untrended and 150-175 trended in good suburbs of major metros which will generally get us to opportunistic returns assuming we procure cheap, high LTC construction debt. 200-300 bps spread is nonexistent in the MF development deals I have underwritten.
This is an asinine question, but when you say "spread" what are you comparing your yields to?
From a non-multi family/east coast operator, we are underwriting our residential at 6-7%, although everything we underwrite at 7% ends up being revised down to the mid to low 6% range. I've revised a few down to the high 5%s but those are in areas where the cost to build is insane and the quantity of units that can be built is limited.
"Spread" in this context means Yield on Cost minus Exit Cap. It's one way to approximate how profitable a deal looks, not accounting for things like leverage, what numbers that spread lies between, etc. It's the juice. It's your take after the blood, sweat and tears you put into acquiring a site, developing a project and selling a stabilized product. If it's a negative number, you have a problem.
Thanks. Makes sense
thanks for the monkey shit. it was a stupid question. this is my first time working in development and we underwrite to hold and only look at stabilized yield (no cash analysis/DCF involved)
I have worked on a few industrial and multifamily developments over the past couple months.
For multifamily we are seeing YTC of about 7% + or - .5% depending on location (primary vs. secondary/urban vs. suburban)
Industrial we are seeing YTC of about 7% with higher exit caps than MF. I think our spread there is closer to 100-125bps. Maybe more depending on the final exit scenario.
D.C. developer here. We are seeing new multifamily returns on cost of 5-7%. Construction costs and land values, pushed by numerous sophisticated, large investors creating a highly efficient bidding market, are really narrowing yields.
Essentially, new real estate development makes no sense unless you are already wealthy or unless you're a large investor. Developments are still pretty profitable for developers who are making fees.
agree with this. construction cost inflation is also out of control right now which is really eroding yields. banks have also become increasingly cautious over the past 3-4 months in terms of construction lending. our group was seeing spreads at 265-275+L maybe 6 months ago and those are now over 300+L for comparable projects.
all those factors increasing your cost basis with no proportional increase in underwritten revenues, seeing more than 150 bps over exit cap is rare (for a deal at market land price)
Believe it or not, we've seen MF construction costs go down in some markets - Florida in particular. Getting absolutely bent over in Atlanta though. Exit caps still absurd between 4 and 5.25
.
.
I want to bump this to see what effect the recent market changes have had in spreads for you apartment developers.
What is happening in multifamily construction lending? Are banks still being overly cautious? Have any markets seen a decrease in construction costs?
In my experience banks are still being overly cautious on new developments, willing and able to lend at lower LTC's, but not at terms that were market 12-18 months ago.
I have seen construction costs continue to creep up but the rate of increase seems to be slowing.
I am currently looking at deals in SLC, Denver, Austin, Portland, Chicago, and some smaller college towns for reference.
Hey, thanks for the update. What's the average LTC you're seeing? 60%? Lower?
Part of banks reluctance to fund new construction is certainly caution but also economic -- banks just don't make enough money on construction loans to justify the risk. I spoke to a major lender a few weeks ago who told me that he gets a shot at the permanent debt on very few of his construction deals because he gets taken out by a life company or agency shortly after completion.
Interested to hear about other markets as well. In DC construction costs are continuing to creep, particularly for trades like concrete and glass. Glass continues to be problematic with extremely long material lead times due to high-rise tower curtainwall construction across the country. But, residential construction which has been out of control is starting to taper--labor, drywall, etc. starting to level off.
Locally, construction financing is drying up, especially for residential. There are just so many units in the DC-area pipeline, that supply issues combined with general market outlook are making banks skittish. Office financing is also getting tighter. Recently went out for term sheets for new construction practically on top of a metro station with a 30% credit pre-lease and only got one offer for partial recourse financing, and proceeds were under 60%. Spreads around L+300.
2nd Edit: Or are you just talking about residential rentals?
I'm a D.C. area guy but haven't been super active in the for-sale residential sphere recently. I'm a bit surprised that there is an issue with for-sale financing due to over-supply. I know a ton of real estate agents and mortgage brokers and their clients can't find a house to save their souls (bidding wars). In fact, for the first time since 2005 I heard about people camping out to get in line for new construction. A friend of mine who is a residential homebuilder in the District of Columbia said there is virtually no supply of units in D.C. (at least relative to the demand), especially for units under $400,000. I'm honestly stunned about what you're saying and I'd definitely like to investigate further (i.e. maybe I shouldn't take my friends' anecdotes at face value).
1st Edit: I just called my buddy who is a residential mortgage broker who does about $70 million per year in production and he was like, "Yeah, my clients are struggling to find anything, especially in the condo market, and especially in the District of Columbia."
I bumped the topic based off questions about multifamily construction, but any reliable info/trends is always welcome. I can't speak for Ricky, but I think that's what he was referring to.
yea sorry if I wasn't clear, I was talking about multifam rentals. But you are right, housing supply in DC is still incredibly constrained and for sale units frequently close above asking price. There are only so many rowhouses, and area developers are increasingly wary of condos because of the warranty issues. Eastbanc just rolled out sales on a sweet condo building in Foggy Bottom and people were lined up overnight outside the sales office for appointments.
Office Bay area is building to +/- a 6 in SF, 100 - 200 bps spread for Peninsula and slightly inside that for Prime Silicon Valley.
Industrial is between a 5.5 and 6.5 if you're LUCKY with exit cap rates typically negative (depending on the site)
We are starved for quality industrial hence the negative spread.
A bit crooked huh?
Edit: Lending for spec office is completed dried up, pre-leased you can lever up to 90% with mezzo / debt fund financing and some creativity.
Multifamily lending is limited (huge pipeline and and fund supply / demand asymmetry). Pre-leasing to some level is usually required.
Spec industrial lending is available still.
Negative terminal caps?? I've never heard of this
My current project:
Eastern Europe Small market, EU member B class office 20k sq ft Development ~10.5% Exit ~8.5% Alternative:Office condominium sale 7.5%
We are going to try to sell it as office condos. Alternatively rent.
teddythebear
Past 3 months here are a few deals that I've taken a serious look at:
Phoenix: YOC - 6.4% (Untrended) - 7.1% (Trended) Exit Cap Rate: 5.75% (Market is 5.00%)
Dallas: YOC - 6.2% (Untrended) - 6.9% (Trended) Exit Cap Rate: 5.5% (Market is 4.75%-5%)
Denver: YOC - 5.8% (Untrended) - 6.9% (Trended) Exit Cap Rate: 5.5% (Market is 4.5-4.75%)
There are MF development deals out there but just not as many as there used to be given the leverage issue and the simple fact that the majority of great land sites have already been taking and land sellers has unrealistic expectations of land pricing at this time.
We are still seeing 65% LTC on deals we have closed but most developers are sending out equity packages out at 60% LTC to be on the conservative side.
Great information. +1
damn, that just goes to show how frothy everything is getting across the country. When you can't even develop to a yield more than 50 bps over assumed exit cap any semi hairy new construction deal just doesn't make too much sense.
Since cap rates cant go much lower, the only way to increase the spread would obviously have to be a higher yield. In terms of multifamily, what would have to change? I can't imagine rents getting much higher, is the problem construction costs?
@MIWP1989MI"
Your Exit caps are based on what time frame?
36 Months? 5 year exit after stabilization? etc.
We are an IRR drive fund so merchant build typically 30 months to 48 month holds until market dictates a hold.
I definitely think there will be several MF deals that will fall through as developers who are unable to find debt / equity will have to drop sites during the next 12 months.
Also I definitely have seen more mezz / pref equity who are able to bridge the construction loan from 60% LTC to 70% - 75% LTC which is what many developers were used to seeing. The blended rate on this debt option is definitely cheaper than bringing straight equity at 60% LTC. Definitely a crowded space but one that would be an interesting space to play in.
Developer debt funds....so hot right now.
@MIWP1989MI"
Great response.
This thread has gotten good. Keep up the information. On another note, I was just told by a friend who is a commercial lender, they are seeing deals in Houston that have exit caps higher than YOC. So this is a negative spread or no spread at all. I guess the builders went in during the oil boom and now with the high supply and oil decline, it killed their returns. Just goes to show you that 90% of development is about timing.
Return on cost = 6% probably more like 5.5%. (Large major metros urban MF)
Debt quotes at 64% LTC at L + 400.
Second the pricing above. Source: lender
People commit to leasing units prior to construction being completed.
Negative spread between return on cost and exit cap, not a negative cap rate. @prospie exactly, construction and land are pricey as all hell.
Just did a deal where the market was building to an 8 and exiting at a 5.75 - 6.
Not making this stuff up, dm me if you want to discuss
Focus on student housing nationally with markets ranging from the Bay Area & Boston to towns with 5,000 permanent residents, but the majority of our developments are expecting YOC in the 6.50-6.75% range, with market cap rates between 5.00-5.50%.
We just looked at a student housing deal that's building to a 7.1% untrended and 7.5% trended in a 4.75% to 5.25% cap market. This is not the norm - this is the best deal I've seen all year. Just pointing out that the good deals are still out there, and they are as you'd guess, off-market.
Single asset student housing with a cap rate in the 4.75% - 5.25% range!? Is this located on an urban campus?
We're contributing land on deals in the Bay Area Peninsula for $125 FAR for office and $85,000 /DU for MF.
Receiving offers on entitled MF land in Orange County for $120,000 /DU. YOC trended for the same deal would be mid-5%.
Do you guys include financing costs in the denominator when you say yield to cost?
yes. stabilized NOI over total project cost basis.
150 - 200bps based on the hold strategy. If we are looking to exit quickly then the spread is typically closer to 200. Those deals are becoming harder to find without assuming escalation in rents.
When underwriting to an "untrended yield on cost" do you include financing costs (e.g. construction interest, origination fee, pmi)? I work at a PE development shop and am trying to end a debate and would appreciate everyone's feedback.
I say no, for the simple concept that market cap rates don't account for the financing costs of a deal. Therefore, if you’re attempting to do an apples-to-apples comparison of the yield premium that you achieve for taking development risk compared to acquiring an asset then you should exclude financing costs in development yield on cost as well.
This whole discussion came up when trying to understand if the 221d4 program makes sense on a deal and somebody said “221d4 would kill our yield on cost due to the origination fees” (please ignore other reasons to not use 221d4 for conversation purposes). This is where I see a major flaw in our underwriting metric since the real money made in real estate is arbitraging good yield with lower debt costs. Including financing costs in yield on cost could lead us to not consider certain loan programs that would actually increase equity yield. I imagine that you’re going to say “that’s why you add financing cost scenarios after the initial yield on cost underwriting to understand the best financing option” which supports my point that we shouldn’t include the financing costs in initial yield on cost underwriting in the first place since the purpose of the yield on cost metric is not to evaluate capital markets assumptions, just property level returns.
I'm guessing 90% of sponsors include financing costs in their YOC calc. I agree that this is technically incorrect but its standard practice.
I agree with you that 90% of sponsors include it as well. The big picture thought is if you approach JV equity shops with a YOC excluding financing costs would your deals look better? Would they ask why you didn't include them in your assumptions and think you're smarter than 90% of sponsors when you explain why? Or would they just say "I think like an employee not an owner and my boss told me to underwrite including financing costs so that's what I'm going to do to achieve my bonus"?
Fine, but the end goal is not to have the prettiest or best looking underwriting, but to make the most money (preferably with as little risk as possible). Yes, excluding financing costs will give you a better idea of what returns look like on a property level, but at a higher level view, who gives a shit? The yield the property generates is only important insofar as it pays you back for your investment. The financing fees are part of the cash you are outlaying, so excluding them means you're not getting an accurate picture of your returns.
I mean, if you go to your principals with a deal that has a 7.5% yoc and one with a 7.75% yoc but has full recourse in the loan covenants, I'd bet they find the non-recourse project far more appealing. Not directly related to your point about financing fees, but more that there are more factors than just yield that go into how attractive a given investment/project is and that looking at yield on cost as the ultimate litmus test for a deal ignores a whole host of other issues that your principals (or you, if it's your money) will find compelling, like project risk & recourse or how many non-cash flow generating dollars are going into a project in fees or overhead, etc.
Apologies if I misunderstood the point you were making, but that last sentence stood out to me
My shop (national developer) doesn't include financing costs in our YOC calculations.
Spreads are still around 100bps for us as well.
Understand this is an old thread. Financing cost make sense to include as they are deal specific costs in the sense of origination fees, loan closing costs, etc. The difference would be on interest expense incurred and paid over the period of the cons/bridge loan.
Any thoughts on this?
Is the debate whether to add financing cost to the denominator (All-In Basis) or net it against the numerator (Net Income)?
I read a good chunk of these posts before realizing this thread is 2 years old! I'm guessing yield on cost vs exit cap is definitely
Qui et veniam sed sed. Omnis nemo a autem et ea totam.
Necessitatibus magnam ducimus maiores nesciunt. Quia vitae ad vero sit saepe. Exercitationem corporis illum facilis velit debitis reiciendis. Eos dolores maxime a aut doloribus laboriosam aut. Officiis qui velit non quaerat autem sit.
See All Comments - 100% Free
WSO depends on everyone being able to pitch in when they know something. Unlock with your email and get bonus: 6 financial modeling lessons free ($199 value)
or Unlock with your social account...
Nisi alias commodi est totam et et sed reprehenderit. Fugit perferendis illum ullam sunt molestias nostrum architecto. Sunt aspernatur rem vitae.
Nobis exercitationem modi voluptatem totam. Labore animi et aut deleniti alias dicta consequuntur perspiciatis. Culpa a possimus harum accusamus doloribus.
Itaque et quae enim et aspernatur perspiciatis. Vero autem est quam veritatis deserunt impedit. Enim laborum aut quia pariatur quia nobis rerum. Et eum facilis laudantium occaecati officiis.
Aspernatur ut facilis nam voluptatum et ut. Consequatur odit rerum laborum sed. Optio in eos voluptate harum modi voluptatem accusamus. Reprehenderit fugiat sunt quo iure.
In iste porro at repellat quaerat. Blanditiis quia suscipit fugit sunt consequatur enim veritatis. Eum facere placeat eveniet excepturi. Et explicabo tempore sed ea ad vel ipsam. Saepe voluptatem error soluta iure. Omnis error nihil quas iste dolor maiores non quaerat.
Quia doloremque inventore voluptas dolores tempore ad quisquam ut. Nesciunt at minima iste aliquid. Quidem ipsam beatae sunt. Non ipsum fugit eos quaerat. Animi nisi est molestias quod eos.
Tenetur fugiat sit quos voluptas incidunt ipsum. Eum et aperiam consectetur recusandae. At mollitia laboriosam ut voluptate id.
Facilis ducimus qui molestias similique vero rerum. Illum architecto debitis temporibus sit pariatur error laborum. Fuga sapiente dolore et sequi animi hic vitae fugiat. Ut nemo quaerat voluptatem fugit quo.