Glossary
Exit Cap Rate (Terminal Cap Rate)
An exit cap rate, also called a terminal or reversion cap rate, is the capitalization rate an investor assumes when estimating a property's sale price at the end of the projected holding period. Forward NOI divided by the exit cap rate gives the projected sale price, which often drives most of an investment's projected return.
Formula
Example
An investor buys a property with $1,100,000 of NOI at a 5.5% going-in cap rate, a price of $20,000,000. Year 6 NOI is projected at $1,300,000 and the exit cap rate is set at 6.0%, giving a sale price of $21,666,667 at the end of year 5. Less 2% selling costs ($433,333), net proceeds are $21,233,333. At a 6.5% exit cap rate, the sale price would be $20,000,000, about $1,666,667 lower.
How it is used in underwriting
In most real estate models, sale proceeds are the largest single cash flow, so the exit cap rate is one of the most important assumptions. Underwriters usually apply it to the NOI of the year after the sale, because a buyer prices on forward income. Equity investors use it to project IRR and equity multiple; lenders use similar logic to test refinance risk at maturity. Because value is NOI divided by the cap rate, small changes produce large swings: in this example a 50 basis point increase cut the sale price by more than 7%. Sensitivity tables on the exit cap rate are standard in investment committee memos.
A common mistake is assuming the exit cap rate will equal or fall below today's going-in rate, effectively counting on market improvement. Prudent underwriting usually adds a spread to reflect an older building, future interest rate uncertainty and the risk of selling in a weaker market. Another mistake is applying the exit cap to NOI that includes temporary benefits, such as a tax abatement that expires. For business acquisitions, the equivalent assumption is the exit multiple of EBITDA, and private equity underwriters often assume exit multiples no higher than entry multiples.
Typical benchmarks
Underwriters commonly assume an exit cap rate 25 to 50 basis points or more above the going-in cap rate, with wider spreads for longer holds, older assets or uncertain markets.
Run the numbers: Cap Rate Calculator
Frequently asked questions
Why is the exit cap rate usually higher than the going-in cap rate?
The property will be older at sale, future interest rates and market conditions are uncertain, and buyers may demand higher yields. Assuming a higher exit cap rate builds in a cushion so projected returns do not depend on cap rates staying flat or compressing over the hold.
What NOI do you use with the exit cap rate?
Most underwriters apply the exit cap rate to the forward NOI, the projected income for the year after the sale, because the next buyer will price the property on what it expects to earn. Some models use the final hold year's NOI instead, so check the convention when comparing projections.
How does the exit cap rate affect IRR?
Because sale proceeds are often the largest cash flow, a higher exit cap rate lowers the sale price and reduces IRR and equity multiple significantly. Running a sensitivity table across several exit cap rates shows how dependent the deal's returns are on the exit assumption rather than on operating income.
Related terms
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