Exit Cap Rate
Exit Cap Rate in Practice
An investor underwrites a five-year hold with NOI at sale projected at $1,200,000. At a 6.00% exit cap rate the projected sale price is $1,200,000 / 0.060 = $20,000,000. Move the exit cap just 25 basis points to 6.25% and the value drops to $1,200,000 / 0.0625 = $19,200,000, an $800,000 haircut from a quarter-point change in one assumption. That sensitivity is why credit committees and equity partners interrogate the exit cap before almost any other number.
Exit Cap Rate: What the Market Actually Requires
The standing convention is to underwrite the exit cap rate at or above the going-in cap rate, commonly 25 to 50 basis points higher on a five-year hold, or roughly 5 to 10 basis points of expansion per year held. The logic is twofold: the building will be older at sale, and assuming cap rate compression as your source of profit is speculation, not underwriting. Equity committees and lenders treat a flat or compressing exit cap as a red flag unless the business plan genuinely transforms the asset's quality or tenancy.
Lenders lean on the exit cap in different places. Bridge lenders and debt funds run a refinance test: can projected stabilized NOI support a takeout loan at conservative permanent-market metrics, using an exit cap stressed above the borrower's number. Construction lenders run the same math against stabilized value. CMBS and life company underwriting is driven by in-place income, but the appraisal's discounted cash flow embeds a terminal cap that shapes value and therefore LTV. Agency underwriting embeds it in the refinance test at loan maturity.
Borrower mistakes cluster around optimism: using today's cap rate for a sale five years out, cherry-picking comparable sales from a hotter submarket, and ignoring that an aging building or a shortening lease profile at exit trades wider. The practical discipline is the sensitivity table: run the deal at the underwritten exit cap, then 25 and 50 basis points wider. If the returns only work within 25 basis points of your assumption, you do not have a real estate deal, you have a bet on the capital markets.
Why It Matters for Your Loan
The exit cap rate quietly controls both your projected equity return and, on transitional deals, your loan proceeds, because bridge and construction lenders stress it in their refinance tests. Underwrite it honestly and sensitivity-test it, and you negotiate from strength when a lender's credit committee stresses it anyway. A deal that survives 50 basis points of exit cap expansion is financeable almost anywhere; one that cannot is a capital-markets bet wearing a real estate costume.
Exit Cap Rate: FAQ
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