Terminal Capitalization Rate

What Is the Terminal Capitalization Rate?

The terminal capitalization rate, otherwise called the exit rate, is the rate used to estimate the resale value of a property toward the finish of the holding period. The expected net operating income (NOI) each year is partitioned by the terminal cap rate (communicated as a percentage) to get the terminal value.

Terminal capitalization rates are estimated in light of comparable transaction data or what is accepted to be fitting for a specific property's location and qualities.

Understanding the Terminal Capitalization Rate

The going-in cap rate is the projected first-year NOI separated by the initial investment or purchase price. Conversely, the terminal capitalization rate is the projected NOI of the last year (exit year) partitioned by the sale price. Assuming this rate is lower than the going-in cap rate, it ordinarily means that the property investment was beneficial.

Most real estate investing experts concur that it's important to match the terminal capitalization rate to the current rate of the market, keeping as a primary concern that it very well might be a more secure test for the development to prod the terminal cap rate up a bit. A dynamic bookkeeping sheet can be helpful to stress test the development project to lay out the highest terminal capitalization rate that would in any case give an adequate upside to investors.

Sagacious real estate investors search for markets and property types for which market capitalization rates are expected to fall since a lower terminal capitalization rate, compared to the going-in cap rate, will result in capital gains, accepting that the NOI won't diminish over the holding period. A portion of the data that must be considered incorporates market interest metrics for every category of room, as well with respect to the services and expenses assumed to be connected with every area of operation.

While what's to come is dependably uncertain, two things are certain about the finish of any holding period: the structures will age and the markets will change. It's subsequently critical that all real estate investors gather and examine however much data as could be expected to accurately pinpoint a terminal capitalization rate for a project.

Illustration of the Terminal Capitalization Rate

An investor purchases a fully occupied property for $100 million. First-year NOI is estimated at $5.0 million. The going-in cap rate is accordingly 5.0%.

After seven years, the investor accepts that the terminal capitalization rate is roughly 4.0%. Last year NOI, which has considered rent heightening en route, is projected at $5.5 million (once more, expecting full occupancy).

The resale value is estimated at $137.5 million ($5.5 million in NOI separated by the 4.0% terminal capitalization, or exit, rate).

Features

• The terminal capitalization rate, or exit rate, is utilized to estimate the resale value of a property toward the finish of the holding period.
• Assuming the terminal capitalization rate is lower than the going-in rate, it for the most part means that the property investment was productive.
• The going-in cap rate is the property's projected first-year NOI separated by the purchase price of the property.