Exit Cap Rate
Also called: Reversion cap rate, Terminal cap rate
The exit cap rate is the capitalization rate assumed to apply when a property is sold at the end of the hold period, and it converts projected final-year net operating income into an assumed sale price.
The exit cap rate is usually the highest-leverage assumption in a real estate model. It applies to the largest cash flow in the projection, arriving at the end of the hold, and a 50 basis point move can swing IRR by several hundred basis points. It is also unknowable, which is an uncomfortable combination.
The convention that keeps underwriting honest is to expand the exit cap rate relative to the going-in rate, on the reasoning that the asset is older at sale and that assuming cap rate compression is assuming the market does your work for you. Underwriting an exit below the going-in rate is not automatically wrong, but it should be an explicit, defended assumption rather than a default.
How to calculate exit cap rate
Reversion Value = Final Year NOI / Exit Cap RateRules of thumb
- Expand 25 to 50 basis points over the going-in cap rate for a five year hold as a baseline convention.
- Always show the exit cap rate sensitivity table. An investment committee will ask for it, and a deal that only works at a compressed exit is a bet on the market rather than on the plan.
Calculate exit cap rate
Related terms
- Capitalization Rate (Cap Rate)
A capitalization rate is a property's net operating income divided by its purchase price, expressed as a percentage, and it represents the unlevered annual yield the property produces at that price.
- Reversion Value
Reversion value is the projected gross sale price of a property at the end of the hold period, calculated by dividing the final year's net operating income by the assumed exit cap rate.
- Internal Rate of Return (IRR)
The internal rate of return is the annualized discount rate at which the present value of a deal's cash flows equals zero, making it the time-weighted compound annual return on invested equity.