Exit Cap Rate: The Assumption That Decides the Return
Most of the money in a commercial deal arrives in one payment, years from now, priced at a cap rate nobody can observe today. Fifty basis points on that one assumption moves the sale price further than any operating number in the model.
What it is, and why it carries so much
The exit cap rate is the capitalisation rate you assume a buyer will apply when you sell. Exit value is the NOI at that point divided by that rate; net sale proceeds is what is left after the loan is paid off and the broker is paid. In most holds, that single figure is larger than every year of operating cash flow put together.
Which puts an uncomfortable amount of weight on a number about a market several years away. You can research a going-in cap rate from comparable sales that have actually happened. An exit cap rate has no comps, because the trades it would be drawn from have not occurred yet.
The usual convention is going-in plus 25 to 50 basis points. The reasoning is sound: the building is older at sale, its leases are closer to expiry, and assuming the cap rate compresses is assuming the market does you a favour. Treat it as a starting point rather than an answer — and if the deal only clears its hurdle at an exit cap tighter than you bought at, the return is coming from the market rather than from anything you did.
You capitalise next year's income, not last year's
A buyer at exit is not purchasing the income you have already collected. They are purchasing what the building earns from the day they own it, so the convention is to capitalise a forward twelve-month NOI — the final hold year’s income, grown one more year.
Two details in that calculation are worth getting right, and both are easy to get wrong.
Grow revenue and expenses separately
Rent and operating costs rarely move at the same rate. Applying one blended growth figure to both flattens the margin silently — the NOI comes out plausible and wrong, in whichever direction the blend leaned.
Take credit loss out first
A forward NOI built from gross income and expenses alone capitalises rent nobody expects to collect straight into the sale price. Credit loss grows with revenue, because it is a share of it, and it comes out before the division.
Example: what the assumptions are worth
Sample inputs
- Final hold year EGI
- $1,200,000
- Final year operating expenses
- $400,000
- Final year credit loss
- $24,000
- Rent growth
- 3.0%
- Expense growth
- 2.5%
- Exit cap rate
- 6.5%
Grow each line by its own rate and the forward NOI is $801,280. At a 6.5% exit cap that is a sale price of $12,327,385.
Now change one thing at a time. Capitalise the trailing year’s NOI of $776,000 instead of the forward one, and the exit value drops by $388,923 — an entire year of growth, left on the table by using the wrong convention.
Blend the growth rates instead of applying them separately — 2.75% to both — and the forward NOI comes out at $797,340. That is $3,940 of NOI, which at a 6.5% cap is $60,615 of sale price, lost to a shortcut that looked like rounding.
And move the exit cap itself from 6.5% to 7.0% — fifty basis points, comfortably inside ordinary market movement — and the price falls from $12,327,385 to $11,446,857. That is $880,527 from one assumption, and it dwarfs both of the others combined.
The failure this calculation hides
A forward NOI grows the income that was actually collected in the final year. It does not know which leases produced that income, or whether any of them are about to end.
So if a material lease expires at or near the end of your hold, the forward NOI assumes that tenant’s rent simply continues — when in reality the space has to be re-let, possibly at a different rent, possibly after months of downtime, and with tenant improvements and a leasing commission to pay. The exit is overstated, and nothing in the number says so.
This is why an exit assumption cannot be read apart from the expiration schedule. Check your WALT and rollover profile against the hold period before trusting any exit value: a five-year hold on a building whose largest tenant expires in year five is not the deal the model says it is.
How to actually use it
- 1
Set it from the going-in rate, not from the answer you want
Going-in plus 25 to 50 basis points is the conventional starting point. Picking the exit cap that makes the IRR clear your hurdle is not underwriting, it is arithmetic in reverse.
- 2
Stress it across a range, always
Run the deal at your assumption, 50 basis points wider, and 100. If it only works at the tightest of the three, you are underwriting a market view rather than a building.
- 3
Check the expirations against the hold
A lease rolling at hold-end breaks a forward NOI silently. Line the expiration schedule up against your exit date before anything else.
- 4
Capitalise forward, and grow the lines separately
Next year's income, not last year's, with revenue and expenses on their own rates and credit loss taken out before the division.
- 5
Net it down to proceeds
Exit value is not what reaches you. Take off the outstanding loan balance and the selling costs — that figure is what the equity actually receives, and it is what the return is computed from.
Frequently asked questions
What is an exit cap rate?
The capitalisation rate assumed when the property is sold at the end of the hold. Exit value is the forward twelve-month NOI at that point divided by the exit cap rate, and that value — less the loan payoff and selling costs — is usually the largest single cash flow in the whole model. It is an assumption about a market years away, which makes it the least knowable input and the most powerful one.
What exit cap rate should I use?
The common convention is the going-in cap rate plus 25 to 50 basis points, on the reasoning that the building is older at sale and that assuming cap rate compression is assuming the market does you a favour. That convention is a starting point, not an answer. What matters more is that you test the deal across a range rather than pick one number: if it only works at an exit cap tighter than you bought at, the return is coming from the market rather than from anything you did.
Why is exit cap rate higher than going-in cap rate?
Usually because the asset is older, its leases are closer to expiry, and the buyer at exit is pricing a building with less remaining term than you bought. Expanding the cap rate is the conservative assumption and the one most institutional underwriting uses by default. Holding it flat assumes nothing changes; compressing it assumes the market improves, which may happen and is not something to underwrite to.
Is exit value based on the last year's NOI or the next year's?
The next year's. A buyer at exit is not purchasing the income that has already been collected — they are purchasing what the building will earn going forward, so the convention is to capitalise a forward twelve-month NOI. Using the trailing year instead understates the exit value, and the gap is exactly one year of growth on the whole income stream.
How much does the exit cap rate actually matter?
More than any operating assumption in the model. On the worked example on this page, moving the exit cap from 6.5% to 7.0% — fifty basis points, well inside normal market movement — takes $880,527 off the sale price. No rent growth assumption, vacancy factor or expense line has that much leverage, which is why the discipline is to stress it rather than to set it.
What is reversion value?
The same thing as exit value, in older language: the value reverting to the owner at the end of the hold. You will see reversion in appraisal and academic work and exit value in investment underwriting. Net sale proceeds is the figure after the loan payoff and selling costs come out, and that is the number that actually reaches the equity.
Does an exit cap rate calculation account for leases expiring at the end of the hold?
Usually not, and this is the trap. A forward NOI that grows the trailing year's collected income assumes that income keeps arriving — including from a tenant whose lease expires the day the hold ends. It does not know that suite has to be re-let, possibly at a different rent and possibly after months of downtime. Where a material lease rolls at hold-end, a straightforward forward NOI overstates the exit. Check the expiration schedule against your hold period before trusting any exit value.
Related guides
What is cap rate?
The going-in number the exit assumption is usually set against.
WALT explained
Whether a lease rolls at hold-end — the thing that breaks an exit NOI.
What is NOI?
The income being capitalised, and where it comes from.
How to read an offering memorandum
Where an optimistic exit assumption usually first appears.
How to underwrite a CRE deal
The full process the exit sits at the end of.
CapEx vs OpEx
What late capital spending does to the number the return rests on.
CRE glossary
Every term, grouped by the question it answers.
Free calculators
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Cash-on-cash calculator
Year-one yield on the cash you put in, and whether the leverage is helping.
IRR calculator
See how far the return moves when the sale proceeds change.
Property valuation calculator
Value income at a cap rate, and see what a price implies.
Cap rate calculator
NOI and cap rate from rent, expenses and price.
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Coverage, and the loan the income supports.
Loan payment calculator
The balance you will be paying off at exit.
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