Risk isn’t just a board game. It’s a central part of any commercial real estate professional’s strategy. After all, the industry is all about weighing risk and reward.
One way to confirm risk is with a yield on cost. This concept verifies that an investment has enough potential return to act on it. If you avoid yield on cost, you’re putting yourself at risk for a costly mistake in the present or future.
What is yield on cost, exactly? How do you calculate it? We discuss all of this in today’s article.
What Is Yield on Cost?
According to Investopedia, “Yield on cost (YOC) is a measure of dividend yield calculated by dividing a stock’s current dividend by the price initially paid for that stock. For example, if an investor purchased a stock five years ago for $20, and its current dividend is $1.50 per share, then the YOC for that stock would be 7.5%.
YOC should not be confused with the term ‘current dividend yield.’ The latter refers to the dividend payment divided by the stock’s current price, rather than the price at which it was initially purchased.”
How to Calculate Yield on Cost
Calculating yield on cost is easier than you might think, as the formula is simply dividing net operating income by investment cost, as illustrated below.
Net operating income / investment cost = yield on cost
Again, the goal here is to determine whether an investment or project is worth the risk, financially. As for a good yield on cost target, it depends on comparative deals and market values, which is one of the reasons why commercial real estate software can be so beneficial.
CRE Software and Risk Management
Yield on cost is a comparative metric, meaning you should use it to compare to similar deals (whether your own or a competitor’s) to gauge the risk. If you apply the same formula above to past deals, you can start to get an idea of a good yield on cost rate for your particular area and portfolio. With tools like Quarem, you can also take a look at metrics for comparative properties in your market, giving you even more insight into yield on cost (and letting you easily use it for forecasting and reports as well).
If you’re interested in seeing how Quarem can help you manage yield on cost and nearly every other area of commercial real estate, request a demo today.