Wealth Opportunities in Commercial Real Estate: Management, Financing, and Marketing of Investment Properties

Does the Project Hit Your Minimum Yield?

Let us say you learn that the project is zoned commercial, that it includes a medical office, that it comprises 132,605 square feet (3.047 acres), and that the asking price is $663,050 ($5.00 per square foot). How do you determine whether or not this project makes economic sense?

Referring back to the chapter's subtitle, what is meant by “Build to a 12 Percent Yield?” Put simply, you have to determine what minimum percentage yield or return is necessary to induce you and your investors to invest in the project. Factors such as area demographics, potential project size, preleasing levels and absorption assumptions, community acceptance or resistance, the structure of the financing, or the tenant mix and quality may be decisive factors in your decision to move forward or to back away. Yet, typically, the initial screening test revolves around the numbers: Does this potential project meet your yield requirements?

If we know the yield that we need to achieve is 12 percent and if we can also figure out the cost of building the project, the unknown, therefore, is the net income. What rental rate must be achieved to yield this return on a given cost? The formula we are working with is:

We therefore might build an economic model with the unknown being the rent you are going to charge tenants. We might work backwards, first estimating the total ...