Cap Rate vs. Yield on Cost
Cap rate vs yield on cost explained — going-in cap measures the price you pay, yield on cost measures the return you build through value-add capex.
By Michael Laudino, LFO Capital LLC · Published 2026-06-17
The going-in cap rate measures the price you pay relative to the income the property produces today; the yield on cost measures the return you build after spending capital to stabilize the asset. Cap rate is a snapshot of the purchase; yield on cost is the forward return on every dollar you put in — purchase price plus capex.
Cap rate is in-place NOI divided by purchase price. It tells you what the seller's income stream is worth at today's market pricing, and nothing more. It does not know about the renovation you're planning, the below-market rents you intend to mark up, or the vacancy you'll burn off.
Yield on cost divides stabilized NOI by total cost — purchase price plus all the capital you'll deploy to get there. It answers the question that actually matters in a value-add deal: for every dollar of total basis, how much income will this asset throw off once the plan is done? The gap between the two is the premium you're underwriting your work to earn.
The discipline is to never confuse the two. A 6.0% going-in cap can look thin until you see it stabilizes to a 6.8% yield on cost — that 80-basis-point lift is the entire reason the deal pencils. Conversely, a deal that buys at a 6.0% cap and stabilizes at a 6.0% yield on cost has added cost without adding return, and the value-add story is fiction. See the full mechanics in our underwriting hub.
Worked example — value-add multifamily
| Line | Amount |
|---|---|
| Purchase price | $10,000,000 |
| In-place NOI | $600,000 |
| Going-in cap rate ($600,000 ÷ $10,000,000) | 6.00% |
| Plus value-add capex | $1,000,000 |
| Total cost | $11,000,000 |
| Stabilized NOI | $750,000 |
| Yield on cost ($750,000 ÷ $11,000,000) | 6.82% |
| Spread (6.82% − 6.00%) | 82 bps |
The discipline: the 82 bps of spread between yield on cost and the going-in cap is the value-add premium — if your capex can't produce it, the deal is just an expensive way to buy market-rate income.
Frequently asked questions
Is yield on cost always higher than the going-in cap rate?
Only if your business plan works. Yield on cost is higher than the going-in cap when stabilized NOI grows faster than total cost. If your capex doesn't lift NOI enough, yield on cost can land at or below the cap you bought at — which means the value-add added no real spread.
What is a healthy spread between cap rate and yield on cost?
Most institutional value-add underwriting targets at least 100-150 basis points of spread between the going-in cap rate and the stabilized yield on cost to compensate for execution risk. Thinner spreads leave no margin if costs run over or rents come in soft.
Which metric should I use to value a stabilized deal?
Use the cap rate. On a stabilized, fully-let asset with no capital plan, there is no incremental cost to build into a denominator, so yield on cost and cap rate converge. Yield on cost only adds information when you are spending capital to change the income.
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