Yield on cost
Sector Deep DivesStabilised net operating income divided by total development cost, compared against the market cap rate to measure development profit.
Also written: development yield
Yield on cost is what a developer earns on what it actually spent, land and construction included. It answers whether building is worth more than buying.
The gap between it and the market cap rate for the finished asset is the development spread, and that spread is the entire compensation for construction risk, leasing risk and the time taken.
When the spread compresses below roughly 100 basis points, most developers stop, because they are no longer being paid for the risk of building rather than simply acquiring a completed asset.
It also explains why development pipelines shut down abruptly when rates move. If cap rates widen while costs stay fixed, the finished value falls, the spread vanishes, and a scheme that was viable becomes uninvestable without anything changing on site.
Worked example
A scheme costs 80 all in and will generate 5 of stabilised NOI, so yield on cost is 6.25%.
Completed assets trade at a 5.0% cap rate, so the finished building is worth 100. That is 20 of development profit and a spread of 125 basis points.