Why It Matters
When you buy an investment property, you rarely plan to hold it forever. The exit cap rate lets you estimate the resale price years into the future by dividing the projected net operating income at the time of sale by the cap rate you expect the market to demand at that point. A higher exit cap rate means buyers will pay less per dollar of income, which lowers your projected sale price. Most investors set the exit cap rate conservatively — slightly above the purchase cap rate — to account for the uncertainty of future market conditions.
At a Glance
- Also called: Terminal Cap Rate, Reversion Cap Rate, Disposition Cap Rate, Sale Cap Rate
- Formula: Projected Sale Price = Year N NOI ÷ Exit Cap Rate
- Used in: pro forma underwriting, IRR calculations, hold-period analysis
- Conservative assumption: exit cap rate is set 25–75 basis points above the purchase cap rate
- Key risk: underestimating the exit cap rate inflates projected returns and can lead to overpaying at acquisition
Projected Sale Price = Year N NOI / Exit Cap Rate
How It Works
Every real estate investment has a beginning and an end. The exit cap rate bridges those two points by giving you a method to assign a future dollar value to the property based on its income at the time of sale.
Here is how it works in practice. You project what the property's cash-flow-analysis will look like in the final year of your hold period — specifically the net operating income (NOI), which accounts for revenue-analysis and expense-analysis. You then divide that projected NOI by your assumed exit cap rate to arrive at an estimated sale price.
Projected Sale Price = Year N NOI ÷ Exit Cap Rate
For example, if you project Year 5 NOI of $120,000 and assume an exit cap rate of 6.0%, the projected sale price is $2,000,000.
$120,000 ÷ 0.06 = $2,000,000
The exit cap rate you choose reflects what you expect buyers to demand from similar properties in that market at the time of your sale. It is not a guarantee — it is an educated assumption. Because you cannot know future market conditions with certainty, the standard practice is to add 25 to 75 basis points to the current purchase cap rate. If you are buying at a 5.5% cap, you might model an exit at 6.0% or 6.25%.
This conservative buffer matters because the exit cap rate directly drives your projected equity — and therefore your projected internal rate of return (IRR). Shading the exit cap rate optimistically by even 50 basis points can meaningfully inflate projected returns, making a deal look better than it likely will perform. The opposite is also true: setting the exit cap rate too high can make a solid deal appear unattractive.
The exit cap rate interacts with the rest of your underwriting. Any rehab-analysis that increases NOI — through rent improvements or expense reductions — flows through to a higher projected sale price. Similarly, your financing-analysis determines how much of that sale price translates into equity after paying off the loan.
Real-World Example
Camille is underwriting a 12-unit apartment building she plans to hold for seven years. The current NOI is $180,000, and the market cap rate for similar properties is 5.5%. She projects that NOI will grow to $230,000 by Year 7 through rent increases and controlled expenses.
When setting her exit cap rate, Camille does not use 5.5%. Instead, she adds 50 basis points to account for market uncertainty and sets the exit cap rate at 6.0%.
Projected Year 7 Sale Price = $230,000 ÷ 0.06 = $3,833,333
She then runs a stress test at 6.5%: $230,000 ÷ 0.065 = $3,538,462 — nearly $295,000 lower. That swing changes her projected equity and IRR by enough to matter for her investment thesis.
Camille also tests an optimistic scenario at 5.5%: $230,000 ÷ 0.055 = $4,181,818. She records all three projections in her underwriting model and makes her acquisition decision based on the conservative case. If the deal only works at 5.5%, she passes.
Pros & Cons
- Provides a structured, quantifiable method to estimate future resale value
- Forces investors to think about exit conditions at the time of acquisition, not just at sale
- Enables IRR calculations and hold-period comparisons across different investment opportunities
- Conservative exit cap rate assumptions create a margin of safety that protects against overpaying
- Future cap rates are inherently uncertain — any projection is an assumption, not a fact
- Small changes in the exit cap rate assumption produce large swings in projected sale price
- Investors can manipulate exit cap rate inputs to make marginal deals appear attractive
- Does not account for individual property condition at time of sale, which affects actual buyer demand
Watch Out
The single most common underwriting error with exit cap rates is using the same cap rate for both entry and exit. Markets compress and expand. A property you buy at a 6.5% cap in a rising market might trade at a 7.0% cap five years later when sentiment shifts. Always model an exit cap rate that is at least 25 basis points above your entry cap rate, and stress-test at 50 to 75 basis points above.
Also watch for deals where the projected return only works if the exit cap rate stays flat or compresses. If the deal falls apart at an exit cap rate just 50 basis points higher than your assumption, that is a sign the return depends on favorable market timing rather than the property's fundamentals. Strong deals should survive a range of exit cap rate scenarios.
The Takeaway
The exit cap rate is how you quantify the end of the deal before you start it. It translates future income into a projected sale price, anchors your IRR calculation, and surfaces how much of your return depends on market assumptions you cannot control. Set it conservatively, stress-test it across a range of scenarios, and never let an optimistic exit cap rate carry a deal that would not otherwise pencil.