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It’s easy to understand what the “going-in” cap rate is for the acquisition of an existing income-generating property. It’s a little murkier when it comes to real estate developments.
To review, the going-in cap rate for an existing property is simply the NOI from either the last twelve months as of the point of acquisition (“TTM”, or “trailing twelve months”), or the forward 12 months NOI (“forward”), divided by the property Purchase Price.
Existing property going-in cap rate = TTM or Forward NOI / Purchase Price
In a development, however, you are going through the process of initially leasing up the property, so the convention in terms of defining the going-in cap rate is to take the forward twelve months’ worth of projected NOI starting at 90 days past the point of stabilization (full occupancy less the systemic vacancy assumed), and dividing that by the Total Project Cost.
Development going-in cap rate = Forward stabilized NOI / Total Project Cost
A helpful way to think about the difference between the two is that with an existing property, you are buying an income stream, whereas with a development, you are manufacturing an income stream where one did not previously exist, and using pre-stabilization NOI as the numerator of your cap rate equation would not be that meaningful on a going forward basis.
The one key metric that many investors look at is the untrended cap rate. This assumes the property was up and operating today. The rents would reflect today’s current market rents, usually supported down the road by an appraisal and current estimated operating expenses. These expenses would reflect the type of buildiing that is being constructed i.e. wrap, podium , garden, etc. The cap rate that is used in this blog is reflecting the trended rents. Again, a number of investors look at this as the trended retun on costs
Hi Jack, thank you for the contribution! Yes, you draw an important distinction here in that I did not specify above whether the development NOI being used as the numerator was based on rents and expenses grown from today’s values or not. The most conservative approach to solve for the development going-in cap rate would be to use today’s rents but trended expenses. That’s often how lenders will stress-test a deal’s economics.