What is unlevered cost of capital in real estate?

What is Unlevered Cost of Capital?

In real estate, the unlevered cost of capital refers to the expected return on an investment property without taking into account any debt financing. It represents the return that investors would expect from an all-equity investment in the property, showcasing the property's intrinsic performance by isolating it from the effects of financial leverage (i.e., borrowing). This metric helps evaluate the underlying risk and return of real estate investments, as it focuses solely on the property's cash flows relative to its equity value, without the distortion created by mortgage or other debt-related costs.

An example of unlevered return in real estate investing is the unlevered Internal Rate of Return (IRR), which calculates the rate of return on an all-equity investment in property, ignoring debt financing. This is contrasted with levered IRR, which includes the effects of borrowing. The choice between using levered vs. unlevered IRR depends on various factors such as risk tolerance, the cost of borrowing, and specific investment details. For instance, leveraging an investment might offer higher potential returns when the cost of borrowing is lower than the return on the investment, but it also increases risk​.