Exit Cap Rate: The Assumption That Decides Your IRR
Half a point on a number years away moves your return more than anything you will do as an operator in the meantime.
0.5 pt = 4.6%
Half a point of exit cap expansion, measured in lost IRR.
What it is
Sale price = Year-of-exit NOI ÷ Exit cap rate
Applied to the NOI of the year after sale — the income the buyer is purchasing.
When you sell, the buyer is not paying for your history. They are buying a forward income stream, and the price they pay is that income divided by the yield they require. The exit cap rate is that required yield, and every multi-year projection contains an assumption about it whether or not it is stated.
Many models hide it behind an appreciation percentage instead. That is the same assumption in friendlier clothing, and it is harder to argue with — which is precisely the problem.
What half a point does
The $240,000 example, sold after five years. NOI has grown 3% a year to $17,394 in the year following sale. Only the exit cap changes:
| Exit cap rate | Sale price | Net proceeds after costs and loan | 5-year IRR |
|---|---|---|---|
| 5.75% (compression) | $302,500 | $112,348 | ≈ 13.1% |
| 6.25% (flat — equals entry) | $278,300 | $89,842 | ≈ 8.4% |
| 6.75% (expansion) | $257,685 | $70,670 | ≈ 3.8% |
| 7.25% (further expansion) | $239,914 | $54,143 | ≈ −1% |
This is the largest single assumption in your model
How to choose one honestly
| Approach | What it gives you | Verdict |
|---|---|---|
| Exit at your entry cap rate | A neutral assumption: the market treats your buyer as it treated you. | The reasonable base case, and what most disciplined underwriting uses. |
| Exit 25–50 bps above entry | A conservative allowance for the building being five to ten years older. | The safer default. Buildings age even when markets do not move. |
| Exit below entry (compression) | Assumes buyers will accept a lower yield than you did. | Requires a specific reason — falling rates, or a submarket genuinely re-rating. Rarely defensible as a base case. |
| Exit at the long-run average for the market | Mean reversion. | Sensible where you bought during unusual conditions in either direction. |
The age argument deserves weight. A property you buy at ten years old is fifteen at exit, with more deferred capital and shorter component lives. Even in a flat market, the buyer is purchasing a slightly worse asset, and 25 basis points of cap-rate expansion is a modest way to reflect that.
What actually moves cap rates
| Driver | Direction | Note |
|---|---|---|
| Interest rates | Rates up, caps up | The dominant force. Buyers price against the cost of debt, with a lag. |
| Rent growth expectations | Growth up, caps down | Why fast-growing metros sustain low caps. |
| Building age at exit | Older, caps up | Predictable and usually ignored. |
| Local supply pipeline | More supply, caps up | Check what is permitted nearby, not just what is built. |
| Capital availability | Tighter credit, caps up | Moves faster than fundamentals in both directions. |
| Insurance and tax trajectory | Rising costs, caps up | Buyers discount markets where expenses are climbing unpredictably. |
The relationship between rates and your exit
How to use it
Run three exits, always: your entry cap, half a point above, and a point above. If the deal only clears your IRR target at the first, you are not underwriting a property — you are underwriting a market forecast with a property attached.
The full analyzer takes an exit cap rate directly as an input to the multi-year projection, so the table above is three keystrokes rather than three spreadsheets. Pair it with the IRR guide and the broader stress test, and remember that the sale itself carries 6 to 9% of costs before any of these proceeds reach you.
Frequently asked questions
What is an exit cap rate?
The capitalisation rate a future buyer is assumed to require when you sell, used to convert the property's forward NOI into a sale price. It is the single largest assumption in most multi-year real estate projections.
What exit cap rate should I use?
Your entry cap rate is a neutral base case, and 25 to 50 basis points above it is the more conservative default, since the building will be several years older at exit. Assuming compression — a lower exit cap than entry — requires a specific, stated reason.
How much does exit cap rate affect IRR?
Enormously. On a five-year hold of a typical leveraged rental, moving the exit cap from 6.25% to 6.75% cuts IRR from roughly 8.4% to 3.8% — a 4.6 point swing from half a percentage point of assumption, with everything else identical.
Is exit cap rate the same as appreciation?
They are two ways of expressing the same assumption. An appreciation percentage implies an exit cap rate given your NOI growth, and vice versa. Stating the exit cap is more honest, because it makes the assumption visible and comparable to what similar properties actually trade at.