When passive investors evaluate a real estate syndication—especially one focused on a value-add strategy—there’s a lot to consider, including:
- Location
- Business plan
- Sponsor track record
- Projected returns
However, one critical metric is often overlooked: yield on cost (YoC). While these terms are traditionally used in ground-up development analysis, they are just as applicable in value-add deals, especially when trying to assess the effectiveness of a sponsor’s business plan.
Understanding and applying this calculation can dramatically improve your ability to spot strong opportunities and avoid overly optimistic or underperforming deals.
What Is Yield on Cost?
Yield on cost is a measure of the income a property is expected to generate after improvements, relative to the total cost of acquiring and renovating it.
Yield on Cost = Stabilized Net Operating Income (NOI) / Total Project Cost (Purchase Price + Renovation + Soft Costs)
It tells you how efficiently the sponsor is converting invested capital into income—not just what the property will eventually sell for.
This leads us to an equally important concept: the “development spread.” This is the difference between the yield on cost and the prevailing market cap rate for stabilized properties. It essentially measures how much value the sponsor is creating through their execution.
For example, if YoC is 6.5% and the market cap rate is 5.5%, the development spread is 1%. A healthy spread like this indicates the project is likely to generate strong equity returns, and has a cushion if market conditions soften.
Trended vs. Untrended Yield on Cost
Not all YoC calculations are created equal. You’ll often hear two variations:
- Untrended YoC: Based on current rents and expenses, immediately after renovations are complete. This reflects today’s market environment and stabilized performance without assuming rent growth or expense reductions beyond what’s achievable short term.
- Trended YoC: Includes future rent growth, lease-up assumptions, and market-wide appreciation—typically two to three years out. This is the sponsor’s projected performance based on economic trends and operating improvements.
Why This Matters
- Untrended YoC is your “as-is” snapshot. It’s the conservative view. If the property were stabilized and fully leased today, how would it perform?
- Trended YoC reflects future upside. It’s valuable, too—but relies on assumptions. These assumptions (rent growth, market strength, expense compression) may or may not come to pass.
As a passive investor, you should ask sponsors to provide both. Untrended YoC shows how solid the deal is right now, while trended YoC tells you how compelling it might become if the business plan plays out.
Why Is Yield on Cost Important for Passive Investors?
1. It shows the sponsor’s value-add execution ability
If a sponsor projects a 6.5% untrended YoC in a market where stabilized assets trade at a 5.5% cap rate, that means they’re adding value from Day 1—even before growth assumptions kick in.
2. It helps you cut through fluffy pro formas
IRR and equity multiples can be manipulated. Yield on cost—especially untrended—keeps the analysis grounded in real, operational performance.
3. It’s a margin-of-safety check
Deals with a strong YoC-to-market cap rate spread have a built-in cushion. If cap rates expand or the market softens, your downside is protected.
4. It sets a benchmark for exit value
A high trended YoC paired with a conservative exit cap rate helps you validate the sponsor’s value creation and resale assumptions.
How to Calculate and Use YoC
Here’s a simple breakdown:
- Stabilized NOI (either current or projected 2–3 years out)
- Total project cost (purchase + rehab + soft costs + fees)
YoC = NOI / Total Project Cost
Example:
- Stabilized NOI: $1.2 million
- Total cost: $14 million
YoC = 1.2 million / 14 million = 8.57%
Now compare that to the market cap rate. If similar stabilized assets trade at 6%, the project is generating income above market value—indicating strong equity growth and potentially a lucrative exit.
Final Thoughts
As a passive investor, you may not be swinging hammers or managing leasing agents—but that doesn’t mean you should skip the numbers. Yield on cost—especially when broken into trended and untrended views—is one of the most effective tools you have for vetting deals and sponsors.
Ask for it. Run your own numbers. And use it as part of a broader toolkit to ensure your capital is being put to work with intention and integrity.
About The Author
Paul has acquired over 200 residential units, by “recycling equity” and/or joint venturing. He has experience in underwriting, acquisitions, raising capital, property management, project management, and is a licensed Realtor.
Paul is also a limited partner, investing in over 40+ deals as a passive investor – Multifamily, industrial, sale leasebacks, preferred equity, 1st and 2nd position notes, ATMs, mixed-use development and private equity.
These experiences have led to the formation of InvestWise Collective, a customizable fund aimed at helping investors diversify out of traditional markets into passive real estate opportunities.