Exit cap rate, also called the terminal or reversion cap rate, is the capitalization rate an underwriter assumes will apply when a property is sold at the end of the hold. It is applied to the NOI in the year after the hold to estimate the resale price, making it the most consequential assumption in most return models.
How Is Exit Cap Rate Used?
Exit cap rate is used to convert a property's future income into an estimated sale price inside a discounted cash flow model. The reversion value equals the NOI in the year after the hold divided by the exit cap rate. For a 10-year hold, analysts cap the year-11 NOI, per The Fractional Analyst and Wall Street Prep, to produce the resale price.
The exit cap rate is not observed, it is assumed, which is what makes it the riskiest input in a model. Because it applies to a large NOI many years out, small changes move the projected sale price and the levered return sharply. Underwriters typically set the exit cap 25 to 75 basis points above the going-in cap rate, adding a margin of safety for the property being older and the forecast being less certain, per Financial Edge.
Convention | Typical spread over going-in cap | Rationale |
5-year hold | 25 to 50 basis points | Shorter forecast, less aging |
7 to 10-year hold | 50 to 75 basis points | Longer forecast, more uncertainty |
Aggressive underwriting | 0 or negative spread | Assumes cap rate compression at sale |
Setting the exit cap below the going-in cap assumes the market will pay a richer price at sale than at purchase. That is a bet on cap rate compression, and it should be labeled as such and stress-tested rather than buried in the model.
Why Exit Cap Rate Matters
Exit cap rate matters because the resale price it produces often dominates a deal's total return. In commercial real estate, the terminal value it feeds commonly represents 60% to 80% of the total value in a discounted cash flow model, per The Fractional Analyst and industry DCF guidance, so the exit cap rate assumption moves the answer more than any single year of rent growth.
Because the reversion is one large cash inflow at the end of the horizon, a small error compounds. Raising the exit cap rate by 50 basis points on a property with $2,000,000 of exit-year NOI cuts the resale price from about $40,000,000 at 5.0% to about $36,360,000 at 5.5%, a reduction of roughly $3,640,000 with no change in income. This sensitivity is why disciplined underwriters run the exit cap across a range rather than committing to one point estimate.
Example
An investor models a 5-year hold and projects year-6 NOI of $1,800,000. The table shows the reversion value at three exit cap rates, computed as NOI divided by the exit cap rate.
Exit cap rate | Calculation | Reversion value |
5.50% | $1,800,000 / 0.0550 | $32,727,273 |
6.00% | $1,800,000 / 0.0600 | $30,000,000 |
6.50% | $1,800,000 / 0.0650 | $27,692,308 |
At a 6.00% exit cap the property sells for $30,000,000. If the buyer at exit demands 6.50% instead, the resale price falls to about $27,692,000, roughly $2,308,000 less on the same income. If the market compresses to 5.50%, the price rises to about $32,727,000. The entire $5,035,000 swing in exit proceeds comes from 100 basis points of assumed exit cap rate.
Variations and Edge Cases
Exit cap rate travels under several names and conventions, and the label can hide what NOI was capped. Terminal cap rate, reversion cap rate, and going-out cap rate all mean the same thing, but which NOI year and which growth assumption feed it vary by model. The table separates the common variants.
Variant | Meaning |
Terminal cap rate | Same as exit cap rate; used interchangeably in DCF models |
Reversion cap rate | Same rate, named for the reversion or resale event it prices |
Spread-to-going-in | Exit cap set as going-in cap plus a basis-point cushion |
Perpetuity growth exit | Terminal value from a growth formula instead of a capped NOI |
The frequent mistake is capping the wrong NOI year. The exit cap rate applies to the income in the year after the hold ends, not the final hold year, because a buyer at exit prices the forward income. Capping the wrong year misstates the resale price and every return that flows from it.
Exit Cap Rate vs Going-In Cap Rate
Exit cap rate is often confused with going-in cap rate, but they price opposite ends of the hold. Going-in cap rate is year-one NOI divided by the purchase price, the yield at acquisition. Exit cap rate is the assumed cap rate at sale, applied to future NOI to estimate the resale price. One is observed at the buy, the other is forecast for the sell.
The relationship between them is a core underwriting choice. A conservative model sets the exit cap 25 to 75 basis points above the going-in cap, so the property is assumed to sell at a lower value per dollar of income than it was bought. A flat or lower exit cap assumes the market improves, which lifts returns and raises the risk that the projection does not hold.
Frequently Asked Questions
How is the exit cap rate calculated?The exit cap rate is an assumption, not a calculation, so underwriters usually set it by taking the going-in cap rate and adding a cushion of 25 to 75 basis points. It is then used to compute the resale price, which equals the year-after-hold NOI divided by the exit cap rate.
Why is the exit cap rate higher than the going-in cap rate?The exit cap rate is usually set higher to account for the property being older at sale and for the greater uncertainty of forecasting income years into the future. Historically PwC investor surveys have shown exit rates averaging roughly 50 basis points above going-in rates on long holds.
What is the difference between exit cap rate and terminal cap rate?There is no difference. Exit cap rate, terminal cap rate, and reversion cap rate are three names for the same assumption: the capitalization rate applied to future NOI to estimate a property's resale price at the end of the hold.
Related Terms
Cap Rate
Going-In Cap Rate
Terminal Value
Internal Rate of Return
Net Operating Income