Does putting more money into the building raise the yield?
Say you bought a building for $25.0M and it throws off $1.5M of NOI a year, a 6.00% yield. Now you spend more on it (new kitchens, a built-out suite, lower bills) and that money earns a return of its own. Drag the spend and its return and watch the yield on everything you have in the building move away from the 6.00% you started at.
After the plan
All-in yield on cost7.50%+150 bps from 6.00%
NOI a year$2.1M+$600K from the plan
Worth at a 6% cap$35.0M+$7.0M over the $28.0M in it
The three yields. All in is the average of the first two, weighted by dollars.
Going in
6.00%
The plan
20%
All in
7.50%
The plan earns 20% on its $3.0M, so it pulls the average up 150 bps from the 6.00% the building earns on its own.
The dollars in the building and the yield each pile earns. The dotted lines mark the $25.0M you paid and the $28.0M you have in it now.
What you bought$1.5M NOI ÷ $25.0M paid = 6.00% going in
The plan$600K more NOI ÷ $3.0M spent = 20% return
All in$2.1M NOI ÷ $28.0M in = 7.50% yield on cost
$0$10.0M$20.0M$30.0M
Purchase price$25.0M
6.00% yield
20% return
Purchase price$25.0M
7.50% yield on cost
Paid $25.0MAll in $28.0M
Purchase price$25.0M
NOI a year$1.5M
Spent on the plan$3.0M
More NOI a year$600K
Purchase price$25.0M
Spent on the plan$3.0M
NOI a year$2.1M
Swipe sideways to see all three bars.
What you bought6.00% on $25.0M
Purchase price$25.0M
The plan20% on $3.0M
All in7.50% on $28.0M
Purchase price$25.0M
$0$10.0M$20.0M$30.0M
Purchase priceSpent on the plan
Paid $25.0MAll in $28.0M
$3.0MOn top of the $25.0M you paid, $28.0M all in
$0: leave it as it is$10.0M: a gut renovation
20%$600K more NOI a year from the $3.0M
0%: the money earns nothing60%: $2K a unit for $100 more rent
What just happened
You paid $25.0M for $1.5M of NOI a year, a 6.00% yield. The plan costs $3.0M and adds $600K of NOI a year, a 20% return on that money. All in you now have $28.0M in the building and it earns $2.1M a year, a 7.50% yield on cost, 150 bps above where you started. The new money earns 20% while the building earned 6.00%, so it pulls the average up. At the same 6% cap the building is now worth $35.0M, which is $7.0M more than you have in it.
Plans that add NOI, and what each one returns
The return on a plan is the NOI it adds in a year divided by what it costs. Some plans that owners run, with that math:
Apartments: renovate a unit for $2,000 and raise its rent by $100 a month. $100 × 12 = $1,200 a year ÷ $2,000 = 60%.
Apartments: put a washer and dryer in a unit for $1,500 and charge $50 a month more. $600 a year ÷ $1,500 = 40%.
Office: build out an empty 5,000 sf suite for $250K and lease it at $25 a foot net, $125K a year. $125K ÷ $250K = 50%.
Self storage: add climate control to 100 units for $200K and charge $20 a month more each. $24K a year ÷ $200K = 12%.
Any building: swap the lights for LEDs for $100K and cut the power bill by $30K a year. Lower bills raise NOI too. $30K ÷ $100K = 30%.
Retail: build a $1.5M drive-through pad in the parking lot and lease it for $150K a year. $150K ÷ $1.5M = 10%.
Relevant formulas
Going-in yieldNOI divided by the purchase price$1.5M ÷ $25.0M = 6.00%
More NOI from the planwhat you spend times its return$3.0M × 20% = $600K
NOI after the planthe old NOI plus the new$1.5M + $600K = $2.1M
All-in costthe purchase price plus the spend$25.0M + $3.0M = $28.0M
All-in yield on costNOI after the plan divided by the all-in cost$2.1M ÷ $28.0M = 7.50%
As a weighted averageeach yield times the dollars behind it, divided by all the dollars(6.00% × $25.0M + 20% × $3.0M) ÷ $28.0M = 7.50%
Changeall-in yield minus the going-in yield7.50% − 6.00% = +150 bps
Worth at the same capNOI after the plan divided by the cap rate$2.1M ÷ 6% = $35.0M
Value createdworth at the cap minus the all-in cost$35.0M − $28.0M = +$7.0M
The return on the plan is the extra NOI it adds in a year divided by what it cost, before any loan. The cap rate stays at 6% so the value moves only with NOI. The months the work takes, the rent lost while a unit is torn up, and the chance the rent bump does not come are left out.
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