Terminal Capitalization Rate

What it is

The terminal capitalization rate (also called the exit rate) is the cap rate used to estimate a property’s resale value at the end of the holding period. It converts the expected net operating income (NOI) in the exit year into a terminal (resale) value.

Formula:
* Terminal value = Exit-year NOI ÷ Terminal capitalization rate

How it differs from the going-in cap rate

• Going-in cap rate = First-year NOI ÷ Purchase price.
• Terminal cap rate = Exit-year NOI ÷ Expected sale price.

If the terminal cap rate is lower than the going-in cap rate (and NOI does not decline), the investor typically realizes capital gains on sale.

How to estimate a terminal cap rate

• Use comparable transaction data (recent sales of similar properties in the same market).
• Align the terminal rate with anticipated market conditions at exit (supply/demand shifts, interest rates, local economic trends).
• Be conservative when forecasting — many developers slightly increase the terminal cap rate to stress-test returns.
• Use dynamic models or spreadsheets to run sensitivity analyses and find the highest terminal cap rate that still meets investor return requirements.
• Consider property-specific factors: property age, tenant mix, rent escalation, operating expenses, and likely capital expenditures.

Practical considerations

• Markets change and buildings age—plan for both.
• Forecast NOI carefully (occupancy, rent growth, expenses) because terminal value is sensitive to exit-year NOI.
• Compare cap-rate assumptions across property types and submarkets; some sectors may see declining market cap rates, improving resale prospects.

Example

An investor buys a fully occupied property for $100 million with a first-year NOI of $5.0 million.
* Going-in cap rate = $5.0M ÷ $100M = 5.0%

Seven years later the investor projects an exit-year NOI of $5.5 million and estimates a terminal cap rate of 4.0%.
* Terminal value = $5.5M ÷ 0.04 = $137.5 million

Since the terminal cap rate (4.0%) is lower than the going-in rate (5.0%) and NOI increased, the investor would realize capital appreciation on sale.

Key takeaways

• The terminal cap rate converts exit-year NOI into an estimated resale value.
• It should be grounded in market comparables and tested for sensitivity.
• A lower terminal cap rate than the going-in cap rate generally indicates potential capital gains, assuming stable or rising NOI.
• Always account for changing market conditions and property aging when selecting an exit cap rate.