How to Calculate Terminal Cap Rate

by

Terminal Cap Rate Calculator

Valuation Results

Estimated Terminal Cap Rate: %

Estimated Sale Price (Exit Value):

Note: The Year (n+1) NOI represents the projected income for the year following the sale.

function calculateTerminalCap() { var entryCap = parseFloat(document.getElementById('entryCap').value); var holdPeriod = parseFloat(document.getElementById('holdPeriod').value); var bpsSpread = parseFloat(document.getElementById('bpsSpread').value); var noiNextYear = parseFloat(document.getElementById('noiNextYear').value); if (isNaN(entryCap) || isNaN(holdPeriod) || isNaN(bpsSpread) || isNaN(noiNextYear)) { alert("Please fill in all fields with valid numbers."); return; } // Calculate Terminal Cap Rate // BPS spread is usually applied annually or as a total. Here we apply it annually per standard modeling. // 100 Basis Points = 1% var totalBpsIncrease = (bpsSpread * holdPeriod) / 100; var terminalCapRate = entryCap + totalBpsIncrease; // Calculate Exit Value: Value = NOI / Cap Rate var exitValue = noiNextYear / (terminalCapRate / 100); // Display Results document.getElementById('resTerminalCap').innerText = terminalCapRate.toFixed(2); document.getElementById('resExitValue').innerText = '$' + exitValue.toLocaleString(undefined, {minimumFractionDigits: 2, maximumFractionDigits: 2}); document.getElementById('resultsArea').style.display = 'block'; }

Understanding the Terminal Cap Rate

In commercial real estate investment analysis, the Terminal Cap Rate (also known as the Exit Cap Rate) is the rate used to estimate the resale value of a property at the end of a specific holding period. It is a critical component of Discounted Cash Flow (DCF) analysis and helps investors determine the potential Internal Rate of Return (IRR) of a project.

How to Calculate Terminal Cap Rate

While there are several ways to determine what a future cap rate might be, the most common method used by underwriters is the "Spread over Entry" method. This involves taking the current capitalization rate (Going-In Cap) and adding a specific number of basis points (bps) for every year the property is held.

The Basic Formula:

Terminal Cap Rate = Going-in Cap Rate + (Annual Basis Point Increase × Holding Period)

Calculating the Exit Value

Once the Terminal Cap Rate is established, the projected sale price of the property is calculated by dividing the Net Operating Income (NOI) of the first year of the next ownership period (Year n+1) by the Terminal Cap Rate.

Exit Value = Year (n+1) NOI / Terminal Cap Rate

Practical Example

Imagine you are purchasing a multifamily property today at a 5.0% Going-In Cap Rate. You plan to hold the asset for 5 years. A conservative underwriting standard suggests adding 10 basis points (0.10%) per year of hold to account for the property aging and potential market shifts.

  • Entry Cap: 5.0%
  • Holding Period: 5 Years
  • Spread: 10 bps per year (Total 50 bps or 0.50%)
  • Calculated Terminal Cap: 5.50%

If your projected NOI for Year 6 is $250,000, your Exit Value would be:

$250,000 / 0.055 = $4,545,454.55

Why the Terminal Cap Rate Matters

The Terminal Cap Rate is one of the most sensitive variables in real estate modeling. A slight increase in the exit cap rate can significantly decrease the projected sale price, which in turn lowers the overall IRR of the investment. Most conservative investors "expand" the cap rate (set it higher than the entry cap) to build in a margin of safety for future market volatility and the natural physical depreciation of the building.

Leave a Comment