A new two-bedroom apartment in a garden-style building, in a moderately priced American metro, rents for something like $2,000 a month. Most people who pay that figure have a vague sense that it is too much and no way to check. This article is the check. We build a representative project on paper, state every assumption, run the arithmetic, and show where each dollar of the rent the building requires comes from.
Two cautions before the numbers. First, the project is illustrative. It is not a real building, and every input is an assumption we chose to be plausible for a wood-frame, surface-parked project in a market where such projects still get built. In a high-cost coastal metro every line would be larger. Second, the figures describe the rent the building requires in order to be financed, not the rent a landlord chooses. As we explain in Why Housing Costs What It Costs, the market sets rent; cost determines whether the building exists.
Reference Project A: 120-unit garden project
$24.27M
$1,996/month
The building
This is Reference Project A, the garden project, the first of the two illustrative buildings used across this site. We assume a 120-unit project of three-story wood-frame buildings wrapped around a courtyard, the type of building that accounts for a large share of new rental housing outside the largest cities. We assume the average apartment has 800 square feet of rentable space and that corridors, stairs, leasing office and mechanical space bring the gross building area to 900 square feet per unit, or 108,000 gross square feet. We assume the site accommodates 180 surface parking spaces, 1.5 per unit, and requires no structured parking.
Each of those choices matters. A concrete podium, a parking structure or a fourth story would change the hard cost per square foot substantially. We chose the cheapest common building type deliberately, so that the required rent we derive is close to a floor rather than a ceiling.
What it costs to build: the development budget
The development budget is the first half of the pro forma. It totals every one-time cost between buying the land and opening the doors. Ours has seven lines.
| Line | Basis | Amount | Per unit |
|---|---|---|---|
| Land | $15,000 per unit | $1,800,000 | $15,000 |
| Building hard cost | 108,000 gsf × $140 | $15,120,000 | $126,000 |
| Site work and surface parking | $10,000 per unit (includes 180 spaces × $5,000) | $1,200,000 | $10,000 |
| Hard cost contingency | 5% of hard cost ($16,320,000) | $816,000 | $6,800 |
| Soft costs | 15% of hard cost | $2,448,000 | $20,400 |
| Government fees and connections | $8,000 per unit | $960,000 | $8,000 |
| Developer fee | 4% of hard, contingency, soft and fees ($20,544,000) | $821,760 | $6,848 |
| Construction financing | Assumed: interest and fees on the construction loan | $1,100,000 | $9,167 |
| Total development cost | $24,265,760 | $202,215 |
Land
We assume $15,000 per unit, or $1.8 million, for a suburban site already zoned for the density we are building. Land is a smaller share of this project than readers might expect, about 7 percent of cost, because we assumed a site where 120 units are allowed. Where permitted density is lower or the site requires rezoning, land cost per unit climbs quickly, and in urban infill it can exceed the cost of the building itself.
Construction
We assume $140 per gross square foot for the buildings themselves, $15.12 million, plus $1.2 million for grading, utilities, paving, landscaping and 180 surface spaces at an assumed $5,000 each. We add a 5 percent contingency for the things that go wrong, which the lender will require in any case. Hard costs plus contingency are $17.1 million, 71 percent of the budget. Construction is the reason the rent is what it is, and the article Why Can’t Developers Build Cheaper Apartments? explains why that number is so hard to move. That article works on Reference Project B, the costlier podium building, so its base rent is $2,415 rather than the $1,996 derived here; the levers it ranks apply to both.
Soft costs, fees and the developer
We assume soft costs of 15 percent of hard cost, $2.45 million, covering architecture, engineering, surveys, legal, title, builder’s risk insurance, marketing and lease-up, and lender fees. We assume $8,000 per unit in impact fees, permit fees and utility connection charges, $960,000, paid to the local government and utilities before construction. We assume a developer fee of 4 percent of the costs the developer manages, $821,760, which compensates the developer for several years of work and for the overhead of a company that carries projects that never get built.
Construction financing
A construction loan accrues interest for the entire build and lease-up period while the building earns nothing. We assume $1.1 million for that interest plus the loan’s origination fee. That figure is an assumption rather than a calculation because construction interest depends on the total cost, which depends on the interest, a circularity that the methodology block explains how we resolved.
What it costs to own: the operating budget
The second half of the pro forma is the year the building is open and stabilized. Every line here recurs annually for as long as the building stands.
| Line | Basis | Annual | Per unit per year |
|---|---|---|---|
| Property taxes | 1.0% of total development cost | $242,658 | $2,022 |
| Insurance | $900 per unit | $108,000 | $900 |
| Operations | $3,200 per unit (management, payroll, repairs, turnover, admin, marketing) | $384,000 | $3,200 |
| Owner-paid utilities | $700 per unit (common areas, water, sewer, trash) | $84,000 | $700 |
| Capital reserves | $300 per unit | $36,000 | $300 |
| Total operating costs | $854,658 | $7,122 |
We assume an effective property tax rate of 1.0 percent of development cost, $242,658 a year, which is the largest operating line. Effective rates vary from well under half a percent to above 2 percent across U.S. jurisdictions, and this line alone can swing required rent by more than $150 a month. We assume $900 per unit for property and liability insurance, $3,200 per unit for everything involved in running the building, $700 per unit for utilities the owner pays, and $300 per unit set aside as replacement reserves for roofs, HVAC and paving. Operating costs total $7,122 per unit per year.
The cost of the money
The $24.27 million does not appear from nowhere. We assume, as our Rent Impact tool does by default, that 65 percent of it, $15,772,744, is borrowed on a permanent loan at 6.5 percent with 30-year amortization, and that the remaining 35 percent, $8,493,016, is equity from investors who require an 8 percent annual cash yield.
Mortgage constant (6.5%, 30 yr) = 0.075848
Annual debt service = $15,772,744 × 0.075848 = $1,196,334
Annual equity return = $8,493,016 × 0.08 = $679,441
Required net operating income = $1,196,334 + $679,441 = $1,875,775The mortgage constant is the annual principal-and-interest payment as a share of the loan balance. In year one, $1,025,228 of the debt service is interest and $171,105 is principal.
The building must therefore produce $1,875,775 of net operating income a year, revenue after operating costs, just to pay its lender and give its investors the yield they require. That is a yield on cost of 7.73 percent, and it gives the lender a debt service coverage ratio of 1.57, comfortably above the 1.20 to 1.25 that lenders commonly require. A project that could not show that coverage would not get the loan.
The required rent
Now the arithmetic runs backward from the obligations to the rent. Add operating costs to required NOI to get the revenue the building must actually collect. Divide by 0.95 to allow for 5 percent vacancy and credit loss, which gives the rent the building must ask for. Divide by 120 units and 12 months.
| Step | Calculation | Result |
|---|---|---|
| Required NOI | Debt service + equity return | $1,875,775 |
| Plus operating costs | + $854,658 | $2,730,433 |
| Gross up for 5% vacancy | ÷ 0.95 | $2,874,140 |
| Per unit per year | ÷ 120 | $23,951 |
| Per unit per month | ÷ 12 | $1,995.93 |
If comparable apartments in this market rent for less, the project is not built. If they rent for more, it is built and the difference is profit until competing supply arrives.
What the required rent is, and what it is not
It is worth being precise about what $1,995.93 represents. It is the average rent across all 120 apartments that this project must be able to show a lender and an investor in a stabilized year in order to be financed. It is not a price list: a one-bedroom would rent below it and a three-bedroom above it, and the mix would be tuned so that the weighted average lands on the number. It is also not a prediction of what the building will actually charge. If comparable apartments in the neighborhood rent for $2,300, the building will charge something close to $2,300 and the difference will accrue to the investors and, through competition for the site, to the seller of the land.
The required rent matters because it is a threshold. If the market rent for this kind of apartment in this location is below $1,996, no amount of goodwill makes the project happen. The lender will not lend against revenue the building cannot collect, and the investors will put their money somewhere that clears their return. The project is redesigned, repriced, delayed, or abandoned. This is the feasibility test, and it is run on every proposed building in the country, usually months before the public hears about it.
That threshold is also why the composition of the number matters more than its size. A building that needs $1,996 because construction is expensive faces a different set of possible remedies than one that needs $1,996 because taxes and fees are high, or because the money is expensive. The stack below is the diagnostic.
Where each dollar of rent goes
The stack below attributes the $1,996 to the eleven categories the Housing Breakdown always uses. Read the basis label carefully. These are required-revenue contributions: for each category, the annual amount the building must collect because of it, grossed up for vacancy and divided by 120 units and 12 months. They are a model of why the rent must be what it is, not a record of where a rent check is literally sent. The cash view follows.
Why the rent must be $1,996: required-revenue contribution by category
Basis: Required revenue
Required rent per unit per month
$1,996/month
- Land$653.3%
- Construction$70635.4%
- Financing$402.0%
- Property Taxes$1778.9%
- Insurance$794.0%
- Operations$28114.1%
- Utilities$613.1%
- Government Requirements$351.7%
- Capital Reserves$261.3%
- Investor Return$49724.9%
- Developer Return$301.5%
See the numbers
| Category ($ per month) | Required revenue | Share |
|---|---|---|
| Land | $65 | 3.3% |
| Construction | $706 | 35.4% |
| Financing | $40 | 2.0% |
| Property Taxes | $177 | 8.9% |
| Insurance | $79 | 4.0% |
| Operations | $281 | 14.1% |
| Utilities | $61 | 3.1% |
| Government Requirements | $35 | 1.7% |
| Capital Reserves | $26 | 1.3% |
| Investor Return | $497 | 24.9% |
| Developer Return | $30 | 1.5% |
How to read the capital lines
The land, construction, financing, government-requirement and developer lines share a convention. Each is the annual debt service on the borrowed 65 percent of its cost: 4.93 cents per dollar per year, which is 0.65 multiplied by the 7.585 percent mortgage constant. The equity that funded the other 35 percent of every line earns its 8 percent yield in a single Investor Return line, because that yield accrues to the owners regardless of which cost their money paid for. Any other convention would be equally defensible and would move dollars between rows without changing the total. We chose this one because it answers the question readers most often ask: how much of the rent is there because of the building, and how much because of the people who own it.
Two consequences of the convention deserve attention. The Financing line is small, $40 a month, because it represents only the construction-period interest that was capitalized into cost. The interest on the permanent loan, $1,025,228 in the first year, is inside every capital line, since it is the cost of carrying the borrowed money that paid for them. Similarly, the Developer Return line, $30 a month, is the carrying cost of the developer fee, not the fee itself; Does Developer Profit Make Housing Unaffordable? looks at the fee, the promote and the risk together, on Reference Project B, whose round $30,000,000 budget makes the waterfall easier to follow.
Who actually receives the rent
The stack above explains the rent. The table below distributes it. This is a cash view: of every $1,996 collected in a stabilized month, this is who receives it.
| Recipient | Annual | Per unit per month | Share of rent |
|---|---|---|---|
| Lender (principal and interest) | $1,196,334 | $830.79 | 41.6% |
| Equity investors (8% cash yield) | $679,441 | $471.83 | 23.6% |
| Operations (management, payroll, repairs, turnover) | $384,000 | $266.67 | 13.4% |
| Local government (property taxes) | $242,658 | $168.51 | 8.4% |
| Vacancy and credit loss (rent not collected) | $143,707 | $99.80 | 5.0% |
| Insurers | $108,000 | $75.00 | 3.8% |
| Utilities | $84,000 | $58.33 | 2.9% |
| Reserves (set aside for replacements) | $36,000 | $25.00 | 1.3% |
| Total | $2,874,140 | $1,995.93 | 100% |
On a cash basis, the lender receives more than four dollars of every ten. The equity investors receive about $472 a month per unit, which is the same $679,441 a year as the Investor Return line above, without the vacancy gross-up. Their 8 percent is a return on $8.49 million that remains at risk; they recover the principal only if the building is eventually sold for at least what it cost. The local government receives $169 a month in property tax on top of the $960,000 in fees it collected up front, and it is not paying any of the mortgage.
What it would take to make this apartment cheaper
Because every figure derives from a stated assumption, it is straightforward to ask what changes the answer. Using the rule that every $1,000 of development cost per unit adds $6.78 to monthly required rent (0.0773 blended capital charge ÷ 0.95 ÷ 12), and that every $1,000 per unit of annual operating cost adds $87.72 ($1,000 ÷ 0.95 ÷ 12):
- Cutting hard cost by 10 percent ($1,512,000, or $12,600 per unit) would cut required rent by about $85 a month.
- Eliminating the $8,000 per unit in government fees would cut required rent by about $54 a month.
- A property tax rate of 2.0 percent instead of 1.0 percent would raise required rent by about $177 a month; a rate of 0.5 percent would lower it by about $89.
- A one percentage point lower interest rate, 5.5 percent, would lower required rent by about $89 a month; see What Happens When Interest Rates Rise 1%?.
- Replacing the 180 surface spaces with a parking structure would raise required rent by roughly $200 a month or more; see What a Parking Space Adds to Rent.
- Investors accepting a 6 percent cash yield instead of 8 percent would lower required rent by about $124 a month, at the cost of less capital being willing to fund apartments.
Reference Project A (the garden project): an illustrative 120-unit three-storey wood-frame project with 180 surface parking spaces; total development cost $24,265,760 ($202,215 per unit); operating expenses $7,122 per unit per year; required rent $1,995.93 per unit per month. Why this project: it is the cheapest common form of new rental housing, so the rent it requires reads as a floor rather than an average. The site's other reference building, Reference Project B, is a mid-rise over a structured garage that costs more to build and more to run and requires $2,415; both are defined side by side on our Methodology page.
Program: we assume 120 units in three-story wood-frame garden/wrap buildings; 800 net rentable square feet per unit; 900 gross square feet per unit (108,000 gross square feet); 180 surface parking spaces (1.5 per unit); no structured parking.
Land: we assume $15,000 per unit ($1,800,000) for a site already zoned for the project.
Building hard cost: we assume $140 per gross square foot ($15,120,000).
Site work: we assume $10,000 per unit ($1,200,000), including 180 surface spaces at $5,000 each ($900,000).
Contingency: we assume 5 percent of hard cost ($816,000).
Soft costs: we assume 15 percent of hard cost ($2,448,000), excluding the developer fee and construction financing.
Government requirements: we assume $8,000 per unit ($960,000) in impact, permit and utility connection fees.
Developer fee: we assume 4 percent of hard cost, contingency, soft costs and fees ($821,760).
Construction financing: we assume $1,100,000 of capitalized interest and loan fees (see methodology).
Total development cost: $24,265,760, or $202,215 per unit, or $224.68 per gross square foot.
Permanent financing: we assume 65 percent loan-to-cost ($15,772,744) at 6.5 percent fixed with 30-year amortization; mortgage constant 0.075848; annual debt service $1,196,334.
Equity: we assume $8,493,016 (35 percent of cost) requiring an 8 percent cash-on-cash yield, $679,441 per year.
Operating costs: we assume property tax at 1.0 percent of development cost ($242,658), insurance $900 per unit ($108,000), operations $3,200 per unit ($384,000), owner-paid utilities $700 per unit ($84,000), capital reserves $300 per unit ($36,000); total $854,658.
Vacancy and credit loss: we assume 5 percent of gross potential revenue.
No rent premium or income from parking, storage, pet fees or other sources is assumed; all required revenue comes from apartment rent.
These assumptions are on the low side of what garden-style projects cost in many U.S. metros today. They are chosen to be plausible, not typical, and the required rent should be read as a floor for this building type rather than a national average.
The pro forma follows the shared rent-math method used across Housing Unpacked and described on our Methodology page. Required NOI equals annual debt service on the borrowed share of cost plus the required cash yield on the equity share. Required revenue equals required NOI plus operating costs, divided by one minus the vacancy allowance. Required rent equals required revenue divided by units and months. Nothing is rounded until display; the cost-stack lines are shown to the cent so that they sum exactly to $1,995.93.
The mortgage constant is the standard level-payment formula: monthly rate ÷ (1 − (1 + monthly rate)^−360), multiplied by 12. At 6.5 percent over 30 years it is 0.075848, or $632.07 per month per $100,000 borrowed.
Construction financing is assumed rather than solved because it is circular: the loan is a share of total cost, which includes the interest. The assumption was sized as a check on reasonableness: a construction loan of roughly $15.8 million at an assumed 7.5 percent, outstanding for 24 months of construction and lease-up at an average balance of about 50 percent, accrues about $1.18 million of interest; a 1 percent origination fee adds about $158,000. We rounded down to $1,100,000 to reflect that part of the interest would be offset by rent during lease-up. Solving the circularity exactly would change required rent by a few dollars.
The cost-stack attribution is a convention, stated in the chart note. Capital categories carry the debt service on their borrowed share (0.65 × 0.075848 = 0.049301 per dollar per year); the equity yield on all capital appears once as Investor Return; operating categories carry their cash cost. Every line is divided by 0.95 to gross up for vacancy so that the lines sum to required rent rather than to collected rent. The cash-distribution table uses no gross-up and instead shows vacancy as its own row.
Omitted from the model: income taxes and depreciation, which affect the investors’ after-tax return but not the rent the building must collect; any return of equity, which in practice comes from a sale or refinancing; rent growth and expense growth over time; lease-up losses beyond the construction-financing assumption; and any ancillary income. Adding rent growth would lower first-year required rent somewhat for investors who underwrite on a multi-year basis; the stabilized single-year view is the more conservative and more common lender test.
This pro forma is a model, not a report on a building that exists. No external data set sits behind it: every figure is either an assumption stated above or arithmetic performed on those assumptions, which is why the whole thing reproduces from the inputs alone. The inputs are where the judgment lives. Hard cost per square foot, operating expenses per unit and the effective property tax rate vary widely between markets and between years, so a reader applying this framework to a particular city should replace our assumptions with local estimates and public records before treating the $1,995.93 as anything other than an illustration.
Higher hard costs, which are the norm in high-cost metros and for any building type with a podium or structured parking, would raise required rent roughly $6.78 per month for every $1,000 per unit added.
Lower financing costs, whether from lower interest rates, higher leverage, longer amortization or subsidized debt, would reduce the 0.0773 blended capital charge and therefore every capital line in the stack. Could Government Finance Housing More Cheaply? quantifies this on Reference Project B, so its rent figures start from $2,415 rather than $1,996.
Ancillary income from parking, storage or fees would reduce the rent the apartments themselves must carry, by exactly the income collected, grossed up for vacancy.
Lower investor return requirements would reduce required rent by $6.21 a month for every 0.1 percentage point, but capital that can earn more elsewhere would not be available at those terms.
Property tax abatements, fee waivers or density bonuses would each reduce required rent by an amount readers can compute from the tables above; the same tables show what each would cost the public.
What this means
The $1,996 is not a markup. About 69 percent of it, $1,371 a month, exists to carry the capital that built the building: land, construction, fees, financing and the returns on the money that paid for them. The remaining 31 percent, $625 a month, pays to tax, insure, operate and maintain it. Take away every dollar of investor return and the building would still need $1,499 a month. Take away the developer’s fee entirely and it would need about $30 less. The rent is high because the building is expensive to create and expensive to carry, and each of the reasons it is expensive was chosen by someone for a reason that seemed good at the time.
That is the finding worth holding onto. If a community wants new apartments to rent for $1,600 instead of $2,000, the tables above show exactly which combination of cheaper land, cheaper construction, lower fees, lower taxes, cheaper money or lower returns would get there, and what each of those would cost someone else. Every article in the Why We Can’t Build series takes one of those levers and pulls it.