From Pro Forma to Value: Converting Development Cash Flows into a Defensible Feasibility Study

5 Star Office

Introduction

Commercial real estate (CRE) development projects involve significant upfront costs and future income streams that must be carefully analyzed. A development pro forma – a detailed projection of costs and revenues – is a starting point, but translating it into a feasibility study means bridging those cash flows into a credible valuation and investment case. In this report-style post, we explore how to convert a development pro forma into a defensible feasibility analysis. We’ll cover methods to connect development-phase cash flows to stabilized net operating income (NOI) and property value, the importance of timing (lease-up and stabilization) in valuation, and approaches to estimating discount rates/WACC using current U.S. benchmarks. Throughout, we emphasize defensibility, transparency, and alignment with best practices for underwriting and investment decisions.

From Development Pro Forma to Feasibility Analysis

A development pro forma typically lays out two phases of cash flows: (1) the planning & construction phase (with cash outflows for land, hard and soft costs, financing, etc.) and (2) the operating phase (with rental income and operating expenses once the project is built). A feasibility study builds on the pro forma by evaluating whether these projected cash flows yield an attractive return relative to their risks. In practice, this means calculating key metrics and performing tests that lenders and investors rely on:

• Net Present Value (NPV) and Internal Rate of Return (IRR): Discount the forecasted cash flows to see if the project creates value (NPV > 0) and what IRR it implies. Recognize that using a single IRR for a development can be tricky – development cash flows carry different risk in different periods. Early-stage outflows are more predictable (hence often discounted at a lower rate), while future rental incomes are riskier and warrant a higher discount rate. A robust feasibility analysis may therefore use phase-specific discounting or scenario IRRs to account for this risk differential.

• Yield on Cost vs. Market Yield: Calculate the project’s going-in cap rate or yield-on-cost (stabilized NOI divided by total development cost) and compare it to market cap rates for stabilized properties (going-out cap rate). This indicates if the development’s income yield justifies the cost. For example, if a project “builds to a 7%” yield-on-cost and comparable stabilized assets trade at a 5% cap rate, the development spread is 200 basis points. Developers typically target a spread of about 150–200 bps (1.5–2.0%) above exit cap rates to compensate for development risk. This spread translates to a gross development profit margin (pre-tax profit as a percent of cost) often in the 15–25% range. If the pro forma doesn’t show a sufficient spread (e.g. only 50 bps), the feasibility is questionable.

• Back-of-Envelope Checks: A defensible study might start with simple, transparent “back of the envelope” calculations. For instance, the “build-to” yield test: Yield on Cost = Stabilized NOI / Total Development Cost. If this yield falls below the required return (say the developer’s 10% target), the project is not feasible. Conversely, if it exceeds market yields by a healthy margin, it warrants deeper analysis. The feasibility study should clearly show such calculations.

Transparency and defensibility are key. Rather than just presenting rosy IRRs, the study should show how those returns are derived, what assumptions drive them, and how sensitive the outcomes are to changes. By translating the raw pro forma into clear metrics (NPV, IRR, yield-on-cost, profit margin) and simple formulas, the analysis aligns with how underwriters and investors make decisions. Next, we’ll dive into bridging the development cash flows to the eventual stabilized NOI and value of the project.

Bridging Development Cash Flows to Stabilized NOI and Value

At the end of a successful development, the project reaches stabilization – typically meaning it’s built, leased up, and producing a steady NOI at market occupancy. The feasibility study must connect the development-stage economics to this stabilized operating reality. Lenders and investors want to see how today’s costs turn into tomorrow’s income and property value.

Stabilized Value via Cap Rate: One common bridge is to project the stabilized NOI and apply an exit cap rate (reflecting market valuation for similar stabilized assets). This yields the project’s gross development value at stabilization. For example, if the pro forma shows a Year 4 stabilized NOI of $1 million and we assume a market cap rate of 6%, the indicated value at stabilization is ~$16.7 million (since Value = NOI / 0.06). Comparing this to the total development cost tells us the potential profit. In this case, if total cost was $14 million, the profit would be ~$2.7M and the profit margin ~19%.

This approach highlights whether the project “pencils out” in terms of value creation: value exceeds cost by a sufficient margin. It’s essentially a residual land value concept in reverse – instead of asking “what’s the land worth?”, we check if Value – Cost = Developer’s Profit is adequate. Indeed, the residual land value formula is often used: Residual Land Value = Gross Development Value – (Construction Cost + Fees + Developer Profit). A feasibility study may use this to determine the maximum land price that still allows the required profit. If the residual land value comes out negative or far below asking price, the development isn’t feasible at the given assumptions.

Yield-on-Cost vs. Exit Cap (Development Spread): Another way to bridge to value is through the development yield spread discussed earlier. Suppose our project’s stabilized NOI is $1M and cost is $14M, yield-on-cost = 7.14%. If the anticipated exit cap rate is 6%, the project’s going-in yield is ~114 bps higher than the market yield. This spread (~1.14%) is the extra return for taking on development risk. Feasibility analysis should clearly state the going-in yield and compare it to exit cap rates or yields on comparable acquisitions. If a developer can buy a similar stabilized property yielding 6%, they will only build new if the yield-on-cost is meaningfully higher (often 1.5–2% higher). In our example, a 7.14% yield vs. 6% market cap is borderline; many developers would aim for closer to 8–8.5% yield on cost if 6% is the exit cap (for a ~200–250 bps spread).

In summary, bridging pro forma cash flows to stabilized metrics involves: projecting stabilized NOI, assigning a reasonable cap rate to estimate value, and ensuring the yield/cost relationship is favorable. A defensible study cites current market data for cap rates (by property type and location) and might note that developers “build to a [target]%” return on cost based on what equity and debt providers require.

Example: If total development cost is $80 million and stabilized NOI is projected at $6 million, yield-on-cost = 7.5%. If similar stabilized assets trade at a 6.0% cap, the stabilized value would be $100M (6.0% of $100M = $6M NOI). This yields a $20M profit and ~25% margin. The feasibility study would highlight these results and likely stress that a 7.5% yield-on-cost versus a 6.0% exit cap provides a ~150 bps development spread – within the typical range needed to justify the project. It would also note that if costs overrun or rents underachieve such that yield-on-cost falls to, say, 6.5% (only a 50 bps spread), the project would no longer meet investment hurdles.

Formulas: To make the analysis transparent, the report should include the key formulas used in the bridge. For instance:

• Going-in Cap (Yield on Cost) = Stabilized NOI / Total Development Cost

• Exit Cap Rate = Stabilized NOI / Stabilized Value (sale price)

• Gross Profit Margin = (Stabilized Value / Development Cost) – 1 (expressed as % profit on cost)

• Residual Land Value = Gross Development Value – (All other development costs + profit) (used to determine how much one can pay for land)

By clearly laying out these calculations, the feasibility study bridges the gap from pro forma assumptions to concrete value indicators.

The Role of Lease-Up Timing and Stabilization

Timing can make or break a development’s feasibility. The lease-up period – the time after construction to reach stable occupancy and cash flow – introduces uncertainty that must be accounted for in valuation. A defensible feasibility study explicitly models the timing of lease-up and tests the impact of delays or shortfalls in occupancy.

During lease-up, the property often operates below stabilized NOI: occupancy might be low initially and ramp up, and there may be concessions/free rent given to early tenants. This means temporary income shortfalls and possibly continued negative cash flow beyond construction completion. In an appraisal context, one method to value a non-stabilized asset is to take the future stabilized value and subtract the present value of lease-up costs and income losses. In feasibility analysis, we do something similar: we explicitly forecast the cash flows during the lease-up phase and see how they affect overall returns.

Key considerations around timing include:

• Stabilization Date: When does the project reach a “stabilized operation” (not just a target occupancy, but normalized cash flow without extraordinary lease-up costs)? The feasibility study should state this date/period. If the pro forma assumes, say, 18 months to stabilization, the analysis might examine scenarios like 24 or 30 months to see the impact.

• Interest Carry and Funding During Lease-Up: If the project uses a construction loan, interest may accrue until a certain occupancy or until refinance at stabilization. A longer lease-up means more interest carry and higher financing costs. Lenders will look at a “lease-up reserve” or interest reserve in the budget. The feasibility study should confirm that financing covers the lease-up period or that the project has sufficient cash to get through stabilization without running out of funds.

• Breakeven Occupancy and Rent: It’s useful to calculate breakeven points, such as the occupancy level needed to cover operating costs and debt service (for instance, the project might breakeven at 70% occupancy – below that it bleeds cash) and the minimum rent per square foot required to meet the developer’s yield target. This provides a margin of safety check. For example, if the pro forma assumes average rent of $35/SF, but breakeven (to hit required NOI) is $30/SF, the project has a cushion. The feasibility report might show that as a breakeven analysis: e.g., “Required Rent for 10% yield = $30/SF, which is 15% below current market rents – indicating a reasonable cushion.”.

• Impact on IRR: Timing affects IRR significantly – cash flows received later reduce IRR. A defensible study could present an IRR bridge illustrating this. For instance, if everything goes as planned the IRR might be 18%, but a one-year delay in stabilization (with corresponding extra costs) might drop it to 14%. Showing an IRR timeline or sensitivity helps investors see how critical timely lease-up is. The study could also break down the IRR into components: e.g. “portion from rental income vs. portion from terminal sale.” For example, an unlevered IRR might be viewed as roughly the going-in yield plus growth; a property bought at a 5% cap with 2% annual NOI growth might yield ~7% IRR. Development projects often have low or negative cash flow initially, so a large portion of the IRR comes from the sale at stabilization – again emphasizing why achieving that stabilized NOI on schedule is so important.

In analyzing lease-up, it’s important to be realistic. The study should not assume 100% occupancy overnight at above-market rents. Underwriters will often assume a reasonable stabilization occupancy (which might be <100% for some assets) and perhaps market-standard lease-up velocity (e.g. X% of units leased per month). As Freddie Mac’s guidance notes, “stabilized operations” is not necessarily 95% occupancy in every case – it could be 85% if that’s normal in that market for that property type. The feasibility study should justify its stabilization assumptions by market data (e.g. “market absorption for Class A office is ~20,000 SF/month, so our 12 months to lease 240,000 SF is in line with history”). By tackling the lease-up period transparently, the study gives lenders/investors confidence that the development can weather the initial lease-up phase and reach the value-creating stage.

Estimating Defensible Discount Rates and WACC for Development

Choosing the right discount rate is central to any DCF analysis. For a development project, this means accounting for higher risk during development and lease-up, and possibly changing capital costs over the project’s life. A common approach is to use the project’s Weighted Average Cost of Capital (WACC) as the discount rate, especially if analyzing the project on a leveraged basis. WACC reflects the blended cost of debt and equity financing for the project.

To estimate a defensible discount rate in today’s U.S. market, consider the following steps:

1. Assess the Risk Profile: Is this a core, stabilized type investment, or opportunistic/development? Development is on the high-risk end of the spectrum. According to industry benchmarks, core stabilized assets might have expected IRRs in the 6–10% range, while ground-up development (opportunistic) deals target IRRs above ~15% (often 15–25%+ for equity investors). This risk profile informs the required return. In other words, equity investors in a development today might demand ~18–20%+ IRR given the uncertainties (higher than they’d demand for a fully leased building).

2. Determine Capital Structure: Identify the likely mix of debt and equity financing. Suppose our project will be financed with 60% debt (construction loan) and 40% equity. The cost of debt can be based on current construction loan interest rates and the cost of equity based on target investor returns for this risk category.

3. Use Market Benchmarks for Component Costs: A defensible study will cite current rates:

   • Risk-Free Rate: The 10-year U.S. Treasury yield (often used as a baseline) is, say, around X% (as of 2025). All else equal, higher risk-free rates push up required returns across the board.

   • Debt Cost: Construction loans might carry an interest rate of SOFR + spread. If today that equates to, for example, ~7% interest. The study could reference recent financing terms or lender quotes.

   • Equity Cost: Based on risk profile, equity may require a mid-teen to low-20s return. For instance, an opportunistic real estate fund might target ~20% gross IRR on a development project. Another reference: opportunistic CRE investments often underwrite ~15–25% IRRs. The higher end accounts for additional risk or if the project has significant leasing/speculative risk.

4. Calculate WACC: Blend the above, weighting by the debt/equity ratio. For example, if debt is 60% at 7% cost and equity is 40% at 18% cost, the WACC = 0.607% + 0.4018% = 11.4%. If there are project-specific taxes or if we consider after-tax costs (interest deductibility), that could adjust the number slightly, but many real estate models use a simplified pre-tax WACC for project feasibility. The discount rate used in NPV calculations should be around this WACC if we are evaluating the levered project cash flows (debt and equity together).

5. Phase-Specific Rates (if applicable): As mentioned earlier, some analyses apply different rates to different phases – e.g., a low discount rate (near risk-free or loan rate) for the relatively secure construction outflows (since construction costs are largely within the developer’s control and have low volatility), and a higher discount rate for the future rental income and sale proceeds (which are subject to market risk). In our example, one might discount the construction costs at, say, 5% (risk-free + small premium) and the future NOI and sale at perhaps 10–12% (to reflect leasing and market risk). This is a more granular method that can be discussed for defensibility.

The key is that whatever discount rate is used, the feasibility study explains why that rate is appropriate. Perhaps cite investor surveys or published data: e.g., “Given current interest rates and required returns, we use a 10% discount rate. This is consistent with a blended WACC for the project: we assume debt at ~6.5% and equity targeting ~18%, yielding ~10–12% WACC, in line with typical development hurdle rates in 2025.”

By rooting the discount rate in market benchmarks (Treasury yields, loan spreads, equity return expectations), the analysis appears credible and defensible. An overly aggressive (too low) discount rate would inflate the NPV and could be flagged by investment committees as optimistic. Conversely, an overly high rate might kill a project that is actually viable – so justification is crucial.

Finally, a decision-tree mindset can be shown (as in the diagram above) to illustrate the process: starting from project risk → to required equity return → to WACC. Lenders and investors will appreciate seeing that the sponsor has thought through the capital cost structure and isn’t just picking a discount rate out of thin air. In some cases, multiple discount rates may be used (for scenario or sensitivity analysis), and the study should clarify that as well (e.g., “We assume 10% as a base discount rate; an 12% rate is tested in sensitivity to show the project still yields positive NPV under a higher hurdle.”).

Feasibility Outputs: IRR Bridges, Breakevens, and Sensitivity

A well-structured feasibility study for a development project will conclude with a summary of outputs – often in a table or dashboard format – highlighting the key metrics and “what-if” analyses. This makes it easy for stakeholders to gauge the project’s viability at a glance. Below is a sample of the kind of outputs and metrics typically presented:

In this example summary, we see metrics like Development Profit Margin (25%) and Yield on Cost (7.5%) which directly tie the pro forma outputs to investment returns. The IRR (15% levered) is shown alongside the assumed WACC/discount rate (9%), indicating a healthy spread of return above the cost of capital (if IRR significantly exceeds WACC, NPV would be positive). We also include breakeven rent and occupancy figures – these provide defensibility by demonstrating the cushion in the underwriting. For instance, if breakeven rent is $30/SF versus a market rent of $35/SF in the pro forma, the project could withstand some market softening and still meet its debt obligations and return targets.

An IRR bridge can also be part of the outputs. This might be a simple chart or narrative explaining the sources of the IRR. One way to articulate it: “Our unlevered IRR of ~9% is composed of a 6% going-out cap rate and roughly 3% annual NOI growth and value appreciation. Leverage then boosts the levered IRR to ~15%. The IRR is sensitive to exit cap rate – if exit cap moves to 7%, the levered IRR would drop to ~11%. We present an IRR sensitivity table to highlight this.” Such sensitivity analyses (e.g., IRR or NPV sensitivity to cap rate, rent level, construction cost variance, lease-up duration) are often included as either tables or tornado charts. They further reinforce transparency and help identify the biggest risk factors.

Alignment with Underwriting Standards: Throughout the feasibility report, the tone should be analytical and candid. Emphasize defensibility – every number comes from either the project’s pro forma or a market data point. If, for example, a discount rate or exit cap assumption is on the aggressive side, acknowledge it and perhaps show a conservative case as well. Lenders in particular will scrutinize the “what if everything goes wrong” scenario (e.g., higher vacancy, lower rents, later stabilization). A truly defensible study doesn’t hide these scenarios – it engages with them. This might be where breakeven analyses are expanded: “Even if rents came in 10% below projections (\$27 instead of \$30), the project’s yield on cost would be ~6.8%, which is roughly breakeven relative to a 6.8% exit cap. The equity IRR in that downside case is ~10%, which is below target but still above our cost of capital – meaning the project would not destroy value.”

Finally, tie the analysis back to investment decision-making best practices. The feasibility study’s purpose is to support a go/no-go decision and to guide terms (like what pre-leasing is required, how much contingency to include, etc.). By converting the pro forma into a rigorous feasibility study, the development team shows that they have an “eyes wide open” view of the project’s financial outlook. This instills confidence among capital partners. It also ensures that the project is structured with realistic assumptions, proper contingencies, and a clear understanding of how value will be created.

In conclusion, moving from pro forma to value is about connecting the dots between a project’s detailed cash flow projections and the high-level metrics that investors and lenders base decisions on. By bridging development cash flows to stabilized NOI and value, respecting the role of timing (lease-up/stabilization), and using defensible discount rates and benchmarks, one can produce a feasibility study that is both comprehensive and credible. Such a study not only calculates returns but also communicates risks, sensitivities, and rationale – aligning the project with underwriting standards and ultimately improving the likelihood of successful financing and execution.

October 24, 2025, by a collective authors of MMCG Invest, real estate feasibility study consultants.

Sources:

• Linneman, P. & Kirsch, B. Real Estate Finance and Investments: Risks and Opportunities – Ch. 10 “Development Pro Forma Analysis”; Ch. 11 “Development Feasibility Analysis” (overview of yield-on-cost, cap rates, and feasibility calculations in development).

• Northspyre Blog – “Cap Rates in Commercial Real Estate (Development Spread)” (developers aim for 150–200 bps yield spread above exit cap to justify ground-up projects).

• First National Realty Partners – What is Residual Land Value & How is it Calculated? (residual land value = gross development value minus all costs including profit).

• SITG Capital – Core vs. Opportunistic Real Estate Strategies (risk/return profiles: core ~6–10% IRR, opportunistic/development 15–25% IRR targets in today’s market).

• Adventures in CRE – From Risk-Free to IRR: Unlocking the Relationship Behind Real Estate Rates and Spreads (relationship of cap rates, growth, and IRR; using risk-free rates and spreads to derive discount rates).

• Freddie Mac Multifamily – Valuing Non-Stabilized Properties Guidelines (methods to account for lease-up in valuation, emphasizing detailed treatment of non-stabilized cash flows in analysis).