Yield on Cost vs Cap Rate: REPE Interview Explanation

Yield on cost and cap rate get mashed together in coffee chats. They are cousins, not twins. Students Google both because development and value-add CIMs brag about YoC, while acquisition memos lead with going-in cap. Interviews test whether you mix pricing a standing asset with measuring return on what you spend to create income.

The 30-second answer

"Going-in cap rate is NOI divided by purchase price or value on an existing asset. Yield on cost is stabilized NOI divided by total project cost, used heavily in development and value-add to show return on all-in spend. Cap rate prices income that is already there or near-term. Yield on cost measures what you built or improved relative to cost basis."

Formulas

Going-In Cap ≈ Entry NOI ÷ Purchase Price (or entry value)

Yield on Cost ≈ Stabilized NOI ÷ Total Project Cost
Total Project Cost ≈ Purchase + hard CapEx + soft costs + carry (± reserves / extras)

Exit cap is different again: it capitalizes exit NOI (or forward NOI, depending on shop convention) to imply sale price. Do not call exit cap "yield on cost."

When each shows up

Why developers care about the spread

If yield on cost is 7.5% and stabilized assets of that quality trade at a 5.5% to 6.0% exit cap, there is a development (or value-add) spread. That spread is not free money. Lease-up, cost overruns, rate moves, and slower stabilization can erase it. Interviewers want you to sound excited about the spread and paranoid about execution.

Worked example

Buy land and shell / building basis, plus CapEx and soft costs:

• Total project cost = $40m
• Stabilized NOI = $3.0m

YoC = 3.0 / 40 = 7.5%

If comparable stabilized assets trade at a 6.0% cap:

Implied value ≈ 3.0 / 0.06 = $50m
Gross value creation vs cost ≈ 50 − 40 = $10m (before risk, timing, fees, tax)

That $10m is model math, not a locked profit. Haircut rents 5% and add $2m cost overrun and the story changes fast.

Going-in cap on the same asset (contrast)

Suppose you instead buy a stabilized twin next door for $50m with $3.0m NOI:

Going-in cap = 3.0 / 50 = 6.0%

Same NOI, different denominator story. You paid market value for income already there. The developer earned (or hoped to earn) the spread by taking construction and lease-up risk on a $40m cost basis.

Value-add version of the same idea

You buy an under-managed multifamily at a 5.5% going-in cap on in-place NOI, spend CapEx on units and common areas, push rents, and underwrite stabilized NOI / (purchase + CapEx + softs) as yield on cost. Going-in cap describes entry pricing. YoC describes the business plan yield on capital you put into creating the higher NOI.

See value-add underwriting and ground-up development for full process detail.

Follow-ups you should expect

More cap rate interview pressure: REPE cap rate questions.

Traps

1. Using purchase price alone as YoC denominator while ignoring CapEx and soft costs.
2. Mixing trailing NOI into a "stabilized" YoC.
3. Comparing YoC to going-in cap on different NOI definitions.
4. Treating development spread as risk-free arbitrage.
5. Forgetting carry / interest during construction in total cost.

Practice drills

Drill 1: Write both formulas from memory, then invent numbers and compute.
Drill 2: Narrate a 40-second development spread with one risk haircut.
Drill 3: Convert a value-add case from going-in cap language into YoC language.
Drill 4: Stress cost +10% and NOI -5%; recompute YoC and implied value.
Drill 5: Explain exit cap vs YoC without using the words interchangeably.

30-second verbal

"Cap rate divides NOI by price for a standing asset. Yield on cost divides stabilized NOI by total project cost for build or value-add. I only compare YoC to market caps after I believe the stabilized NOI and the full cost budget."

Practice on SheetRank

Sunbelt-style RE cases force you to keep entry pricing, cost basis, and exit capitalization in different mental buckets. Walk the model and say which metric you are using at each step.