Yield On Cost

Yield on cost (YOC) refers to the metric that measures the project returns by the total project cost. The purpose of the YOC is to determine the actual returns obtained on a project considering the price initially paid for the real estate project.

YOC is a popular metric used in real estate and equity stocks. It measures the risk-return potential of a project. Also, it assists investors in demonstrating the growth of investment over the years. Furthermore, they can also use this yield on cost calculator to compare the yields of different investments as well. 

Yield on cost is a financial formula useful in determining the project's return on investment (ROI) over its initial invested amount. Real estate developers and investors mostly use this metric for return calculations. Thus, if the initial cost is lower than the project returns, the real estate yield on cost will be higher. It creates a positive image among the investors for that investment. However, this high YOC also brings in heightened risk for the investors. For instance, if the peer YOC is 50% and a particular project is 67%, it may signal a riskier side of the investment. Hence, it is advisable to compare with the market peers considering their original costs. 

The real estate yield on cost calculation involves a trended or untrended approach. As the term suggests, the trended approach takes growth prospects and projections into account. In contrast, the untrended approach uses current rents but considers no growth in the same. While investors use this method for gaining a conservative outlook, the trended method enables a forecast of future performance. 

In equity stocks, dividend yield on cost is crucial in estimating the dividend growth over a period. It is associated with the initial price paid for the stock compared to its current dividend. However, it differs from dividend yield, where the stock's current price is considered instead of its original purchase cost. For instance, if a person bought a stock at $20 per share and the current dividend is $2.5 per share, then the dividend yield on cost is 12.5%.

Nevertheless, it is important to consider the YOC of other companies as well. In other words, if a company has a good YOC, the chances of having a lower current dividend yield are high. During such times, investors prefer to sell their equity holding (shares) in that company and switch to a high dividend-paying stock. 

Let us look at the formula through which we can perform yield on cost calculation for major projects and equity investments:

YOC = Stabilized Net Operating Income (NOI) ÷ Total Cost

Or 

YOC = Current Dividend Yield / Original Price Paid

Where, 

• YOC - Yield on cost, which is often expressed as a percentage. 
• NOI (Stabilized Net Operating Income) - Property income less expenses until it reaches stable operations. 

Total cost refers to the amount invested in that property or project. 

The current dividend yield is the dividend payable by the company to shareholders today. 

Likewise, the original price paid is the actual price paid by an investor to buy that stock. However, it should not be confused with the current stock price in the market. 

Following are some examples of how to use the yield on cost calculation to determine the accuracy of returns on projects. Let us look at them:

Example #1 

Suppose John bought a property years ago on the sidesurf of Los Angeles City. At that time, he invested around $5,00,000. Since then, the property went on lease, which now generates a hefty rent of $2500 to satisfy John's monthly needs. During this entire period, there were some additional charges to the property, like maintenance, property taxes, and house insurance, which cost around $25,000. Now, John wanted to know whether the property was actually profitable or not.

1. Calculating NOI (Net Operating Income):

• NOI = Annual Rental Income - Annual Operating Expenses
• NOI = ($2,500/month * 12 months) - $15,000
• NOI = $30,000 - $15,000
• NOI = $15,000

2. Determining YOC:

• YOC = NOI / Purchase Price
• YOC = $15,000 / $500,000
• YOC = 0.03 or 3%

In this case, John earned a YOC of 3%, which is comparatively less than what he invested overall. 

Example #2

According to news published in May 2024, industry spectators that popular investor Warren Buffet earned a YOC of nearly 60% (59.7%) on Coca-Cola's original investment. In 1988, when originally invested, Berkshire Hathaway acquired shares at $1.3 billion. However, fast forward to 2024, the company now has an investment value of $24.7 billion with 400 shares. Mentioning the same, Buffet also addressed the power of patience and its truth in identifying worthy businesses.

Let us look at some of the advantages and disadvantages of YOC pertaining to investors dealing in real estate and equity stocks:

Following are the points that explain the difference between YOC, cap rate, and cash-on-cash return metrics. Let us understand the table for more clarity: