Build-to-rent calculator: yield on cost, spread and land price

How the yield on cost is worked out

Gross potential rent is the monthly rent times twelve, plus other income like pet and parking fees. Take out vacancy and credit loss to get the income you actually collect. Then subtract the operating costs: property tax, insurance, repairs and turnover, the HOA and common areas, reserves, other costs, and property management as a share of what's collected. What's left is net operating income, or NOI.

Yield on cost is NOI divided by the all-in cost to build: land, vertical construction, site work, and soft costs and financing. Divide NOI by the market cap rate instead and you get what the finished community would sell for. The gap between the two rates is the development spread, which is what pays you for building it.

NOI           = (rent + other income) × 12 × (1 − vacancy)
                − management − operating costs
Yield on cost = NOI ÷ all-in cost per home
Value         = NOI ÷ cap rate
Spread        = yield on cost − cap rate

A worked example: 120 homes

Say you build 120 homes that rent for $2,400 a month, with $75 a month of other income and 6% vacancy. Each home collects $27,918 a year. Property tax, insurance, repairs, the HOA, reserves and other costs come to $7,620, and 7% management adds $1,954, leaving $18,344 of NOI per home.

Each home costs $285,000 all-in: $45,000 of land, $185,000 to build, $30,000 of site work and $25,000 of soft costs and financing. That's a 6.44% yield on cost.

At a 5.25% cap rate, each home is worth $349,405 once it's leased up. That's a spread of 119 basis points and $64,405 of profit per home, or $7.7 million on the community.

To hit a 6.75% yield on cost instead, the all-in cost would have to come in at $271,759 a home. With the same build, site and soft costs, that leaves $31,759 a home for the land, $13,241 less than the $45,000 in the budget.

What moves the deal most

The yield on cost is mostly a rent and cost question. The profit is mostly a cap rate question, because the exit value is NOI divided by a small number.

A quarter point on the exit cap rate takes about $15,900 off every home's value, which is $1.9 million across the community, and half a point takes nearly half the profit. Property tax hits harder than it looks, because it comes straight out of NOI and the land solve: $1,200 a year more in tax leaves $13,981 a home for the land at the same target instead of $31,759.

Operating costs to check

In the example, operating costs come to 34% of the income collected. The lines that most often come in higher than planned:

• Property tax on the finished homes. Tax on the land you bought says little about tax on 120 finished rentals, and the state section below shows why it differs so much by state.
• Insurance, which has risen fast across the Southeast and is quoted per home and per year.
• Repairs and turnover, which grow as the homes age and as residents move out.
• Leasing and marketing during lease-up, and utilities on the homes that sit empty while they lease.
• Reserves for roofs, HVAC and water heaters. New homes don't need them right away, but a buyer will underwrite them.

Property tax on rental homes, by state

Property tax is often the biggest operating cost on a rental home, as it is in the example, and states treat a rented home very differently from an owner-occupied one. Budget the tax on the finished, reassessed homes.

At the same tax rate, a rented home in South Carolina is assessed at one and a half times what the same home would be owner-occupied, before the school operating millage, and in Alabama at twice. In the example, $1,200 a year more in property tax takes the yield on cost from 6.44% to 6.02%.

Terms used here

Gross potential rent

What every home would bring in a year at full rent with no vacancy.

Effective gross income

Rent and other income after vacancy and credit loss: what you actually collect.

Net operating income (NOI)

Collected income less operating costs, before debt payments and income tax.

Yield on cost

NOI in a stabilized year divided by the all-in cost to build. Also called return on cost or development yield.

Cap rate

NOI divided by what a buyer pays for a leased-up property. A lower cap rate means a higher price.

Development spread

Yield on cost minus the market cap rate, usually in basis points. It's what pays a developer for building instead of buying.

Basis point

A hundredth of a percentage point. 119 basis points is 1.19 points.

Stabilized

Leased up to normal occupancy, with concessions burned off.

All-in cost

Land, vertical construction, site work, soft costs and financing, per home.

Assumptions

• One stabilized year, fully leased apart from your vacancy rate. Lease-up time, concessions and rent growth aren't modeled.
• Costs are in today's dollars, with no growth.
• Management is a share of collected income. Every other operating cost is per home, per year.
• Value is NOI divided by the cap rate, before the costs of selling.
• The example numbers are round figures to show the math. They aren't figures for any market.

For the full pro forma, line by line, and how to underwrite a build-to-rent deal, read the build-to-rent pro forma guide. If the land is the open question, the residual land value calculator works the for-sale side of the same site. REOS also tracks which builders hold lots and what lots sell for.

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