The direct answer
Yield on cost compares stabilized NOI with total project cost, while cap rate compares NOI with property value or price. The difference between a project’s stabilized yield on cost and an applicable market cap rate is often called a development spread, but that spread is not a guaranteed profit margin.
Keep cost and value separate
Yield on cost asks what income the project produces relative to dollars invested in creating or repositioning it. Cap rate asks what income represents relative to market value or acquisition price. Mixing the denominators can hide whether value creation actually occurred.
To apply the approach to an editable scenario, use the Commercial Real Estate Investment Calculator. For the neighboring question, explore Cap Rate Calculator.
Interpret the spread as a feasibility signal
If stabilized yield on cost is meaningfully above the market cap rate supported for comparable stabilized assets, the model may imply value creation. The conclusion still depends on lease-up, timing, exit pricing, capital costs and whether the NOI assumptions are achieved.
Stress both sides of the spread
Construction cost overruns can reduce yield on cost, while market repricing can increase the exit cap rate and reduce value. Sensitivity analysis should therefore test cost, NOI and market cap rate rather than relying on one base-case spread.
Worked example
A project costing $10 million with expected stabilized NOI of $750,000 has a 7.5% yield on cost. If comparable stabilized assets trade around a 6.0% cap rate, the modeled spread is 1.5 percentage points; that does not guarantee the project will sell at a 6.0% cap rate.
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Common mistakes and limitations
Do not describe the development spread as locked-in value. Both stabilized NOI and market cap rate are uncertain until realized.
Does not calculate commercial loan terms, taxes or future sale value unless supplied in an optional scenario mode.
Frequently asked questions
Is yield on cost a valuation cap rate?
No. Yield on cost uses project cost, not market value, as the denominator.
Does a positive spread guarantee a profitable development?
No. Timing, financing, cost overruns, lease-up and market repricing can materially change the outcome.
Sources and further reading
The article’s examples are illustrative arithmetic. The references below provide context for operating, valuation or transaction concepts; they do not endorse the assumptions or the calculator.
- Office of the Comptroller of the Currency — Comptroller's Handbook — Commercial Real Estate LendingNOI, direct capitalization, cap-rate valuation and DCF concepts for commercial real estate.
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