Yield on cost

Yield on cost is the development equivalent of a cap rate. Where a cap rate divides income by what a building would sell for, yield on cost divides income by what it cost to build. Developers compare the two: if a finished building can be sold at a cap rate lower than the yield on cost, the project creates value; if not, it would be cheaper to buy an existing building than to build a new one.

Yield on cost = stabilized NOI ÷ total development cost

The gap between yield on cost and the market cap rate, often called the development spread, is the compensation for taking on construction risk, lease-up risk, and years of waiting before the building produces income. Developers and their investors require that spread; when it disappears, they stop starting projects.

For housing costs, this ratio explains why cost increases turn into rent increases so reliably. If a fee, a delay, or a design requirement raises total development cost and the required yield does not change, net operating income has to rise in proportion, and rent is the main lever a new building has to raise NOI.