Methodology
Many of our articles end with a figure of the form “this adds about $X per month to the rent.” This page explains where that figure comes from. The model is deliberately simple, every input is printed with every result, and readers can change the inputs in the Rent Impact tool. If you understand this page, you understand every number of that kind on the site.
What “required rent” means
A new building has to pay for itself. The money spent to build it is borrowed from a lender and invested by owners, and both expect to be paid: the lender through scheduled debt service, the owners through a return on their equity. On top of that, the building has operating costs and will not be fully occupied every day of the year.
The required rent is the monthly rent per unit at which the building’s revenue is just enough to cover all of those obligations. It is not a prediction of what a landlord will charge; the market decides that. It is the floor below which the project would not be financed and therefore would not be built. When we say a requirement “adds $68 per month to rent,” we mean it raises that floor by $68 under stated assumptions.
The model
We start with a capital cost, the dollars a given input adds to the total development cost of a project, and the number of units that cost is spread across. We then ask what annual revenue is needed to carry that capital, and divide it into a monthly figure per unit.
loan amount = capital cost × loan-to-cost
annual debt service = monthly mortgage payment(loan amount, interest rate, amortization) × 12
annual equity return = capital cost × (1 − loan-to-cost) × equity yield
required NOI = annual debt service + annual equity return
required revenue = (required NOI + added operating cost) ÷ (1 − vacancy)
rent impact per unit = required revenue ÷ units ÷ 12NOI is net operating income: revenue after operating expenses and before debt. The mortgage payment uses the standard fixed-rate amortizing formula; at 6.5% over 30 years the annual payment is 7.585% of the loan amount, a figure known as the mortgage constant.
Default assumptions
Unless an article states otherwise, its figures use the defaults below. They were chosen to be reasonable, round and easy to reason about, not to describe any particular market or moment. An article’s own Assumptions block always governs; where it lists a different value, that value was used.
| Input | Default | What it represents |
|---|---|---|
| Loan-to-cost | 65% | Share of the capital cost funded by the [[construction-loan|loan]]; the rest is equity |
| Interest rate | 6.5% | Annual rate on the loan |
| Amortization | 30 years | Period over which the loan is repaid; sets the monthly payment |
| Equity yield | 8% | Annual [[cash-on-cash|cash return]] the equity requires on the dollars it contributes |
| Vacancy and credit loss | 5% | Share of potential revenue not collected in a normal year |
| Added operating cost | 0 | Extra annual operating expense caused by the input, if any (stated when used) |
A worked example
Suppose a requirement adds $1,000,000 to the cost of a 100-unit building. Under the defaults:
loan = $1,000,000 × 65% = $650,000
annual debt service = $650,000 × 7.585% = $49,301
equity = $1,000,000 × 35% = $350,000
annual equity return = $350,000 × 8% = $28,000
required NOI = $49,301 + $28,000 = $77,301
required revenue = $77,301 ÷ 0.95 = $81,370
rent impact = $81,370 ÷ 100 units ÷ 12 = $67.81 per unit per monthEquivalent to about $68 per month for every $10,000 of cost per unit, under the default assumptions.
Added capital cost: $1,000,000 (illustrative).
Units: 100 (illustrative).
Loan-to-cost 65%; interest rate 6.5%; 30-year amortization; equity yield 8%; vacancy 5% (site defaults).
No added operating cost.
Result is rounded to the nearest dollar for display; the underlying value is $67.81.
The two reference projects
Some articles do not measure what one input adds to an existing building; they build a whole building on paper and ask what rent it requires. Rather than invent a new set of assumptions each time, we use two illustrative projects and name them. Every article that needs a whole building states which one it uses, and why, in its Assumptions block.
Both projects have 120 units and both are financed on the defaults in the table above: 65 percent loan-to-cost, 6.5 percent over a 30-year amortization, an 8 percent equity yield and a 5 percent vacancy allowance. Any difference between their required rents is therefore a difference in the building, never in the method.
| Assumption | Reference Project A — the garden project | Reference Project B — the podium project |
|---|---|---|
| Building | Three-storey wood frame, 900 gross square feet per unit | Mid-rise over a structured parking garage |
| Parking | 180 surface spaces at an assumed $5,000 | 120 structured spaces at an assumed $30,000 |
| Total development cost | $24,265,760 | $30,000,000 |
| Cost per unit | $202,215 | $250,000 |
| Operating expenses per unit per year | $7,122 | $8,200 |
| Property tax assumption | 1.0% of development cost ($2,022 per unit) | 1.0% of development cost ($2,500 per unit) |
| Required rent per unit per month | $1,995.93 | $2,414.50 |
Project A is the cheapest common form of new rental housing, so the rent it requires reads as a floor rather than an average. It is derived line by line in Why a New Apartment Costs $2,000 a Month, and it is also the base for our work on parking and interest rates.
Project B is the form that gets built where land is expensive enough to stack cars. Its round $30,000,000 budget makes a capital stack and an equity waterfall easy to follow, so it carries our work on developer profit, delay, construction levers and public capital.
Why B costs more to run as well as to build
The podium project is assumed to cost more per unit per year to operate, not less. A structured garage has to be lit, ventilated, swept, gated, sealed and eventually restored; a podium building has elevators, more common area and more building systems; and a costlier building carries a larger property tax bill at the same effective rate. We apply the same assumed rate, 1.0 percent of development cost, to both projects, which is deliberately on the low side of the U.S. range.
| Line | Project A (garden) | Project B (podium) |
|---|---|---|
| Property taxes | $2,022 | $2,500 |
| Insurance | $900 | $1,000 |
| Operations | $3,200 | $3,500 |
| Owner-paid utilities | $700 | $800 |
| Capital reserves | $300 | $400 |
| Total | $7,122 | $8,200 |
Two consequences follow, and they are worth stating plainly because a reader moving between articles will notice them. The podium project requires about $419 a month more than the garden project, of which roughly $324 is the extra capital and roughly $95 the extra operating cost. And a dollar figure expressed as a share of rent will differ between the two: the developer fee that is 2.8 percent of Project B’s rent would be a larger share of Project A’s, because the denominator is smaller. When we quote a percentage, it is always a percentage of the project named in that article.
Neither project is real. Every figure is either an illustrative assumption we chose to be plausible, or arithmetic derived from one.
Both use the site defaults in the table above; neither introduces a different financing method.
Both apply an assumed effective property tax rate of 1.0 percent of total development cost, which is low relative to the U.S. range. A higher rate raises both required rents.
The two required rents differ because the buildings differ. A reader who sees $1,996 in one article and $2,415 in another has not found an inconsistency.
Neither rent is a prediction of what any building will charge. Each is the rent the building must be able to show in order to be financed.
Our Housing 101 lessons use a third and simpler teaching example, a 100-unit building costing $24,000,000, because round numbers are easier to follow when the arithmetic itself is the subject. It is stated in each lesson and is not one of the two reference projects.
Why we say “modeled” and “illustrative”
The figure above is not an observation. Nobody measured a $68 increase in anyone’s rent. It is the arithmetic consequence of inputs we chose. We call such results modeled, and we call the inputs illustrative when we assumed them rather than took them from a source. The labels are not hedging; they tell you exactly how much weight the number can bear. A modeled figure is only as good as its inputs, which is why we always print them.
Where an article uses an observed input, for example a fee schedule from a published ordinance, the source is cited and the input is labeled as actual. The arithmetic that follows is still modeled.
How we treat the details
Rounding
The model never rounds internally. Every intermediate value is carried at full precision and only the displayed figures are rounded, to the nearest dollar for rents and to the nearest thousand or million for large costs where the text says so. Because of this, displayed lines in a table may not add exactly to a displayed total.
Vacancy
Dividing by (1 − vacancy) converts the income a building needs into the rent it must ask, since some share of asking rent is never collected. We apply the allowance to the whole required amount, including the added operating cost, because a vacant unit pays neither.
Operating expenses
The core model is incremental: it measures what one input adds to rent, so it includes operating cost only when the input itself creates one (a garage that must be lit and cleaned, for example). Articles that model a whole building’s required rent, such as the Housing Breakdown, add the full operating expense budget explicitly and list it in their assumptions; the budgets for both reference projects are set out above.
Equity returns
We express the equity requirement as a simple annual cash yield on the dollars invested. Real investors think in terms of internal rate of return, preferred returns and eventual sale proceeds, and a full pro forma would model all of them. A single cash yield is a simplification that keeps the arithmetic transparent; the default of 8% is a stand-in for “the return required to attract the money,” not a report of what investors currently earn.
Limitations
- The model is linear. It assumes an added cost is financed on the same terms as the rest of the project, which is usually but not always true.
- It is static. It does not model rent growth, expense growth, refinancing, sale, depreciation or taxes on income.
- It treats all units alike. Real buildings spread cost unevenly across a unit mix, and the market may not accept the same increase on every unit.
- It says nothing about whether the market will pay the required rent. That is a separate question, which we address in our supply and demand coverage.
- The defaults are assumptions. Change them in the Rent Impact tool and the result changes with them.
These limits are why we describe results as “about” a figure and pair every one with its assumptions. A reader who wants a different answer can usually get one by changing an input; the value of the model is that it shows which input, and by how much.