Underwriting
The Exit Cap Rate Nobody Can Verify
Exit cap rate is an assumption about conditions years away that often drives a large share of modelled proceeds, which makes it the least verifiable input carrying the most weight.
Most hold-period models end with a sale, and that sale is valued using an assumed exit capitalisation rate. It is an assumption about the future that cannot be checked against anything.
Why the input carries so much weight
In a model with a sale at the end, a large portion of total modelled proceeds arrives in that final year. The exit assumption therefore scales a substantial share of the outcome.
Small changes produce large swings. Moving the exit rate modestly in either direction can change the modelled sale price enough to alter whether the deal appears viable at all.
This asymmetry is uncomfortable because the input with the greatest leverage is also the one with the least evidence behind it. Nobody observes capitalisation rates years in advance.
Where the convention of expansion comes from
A common practice is to assume the exit rate is slightly higher than the entry rate. The reasoning is that the building will be older and that conditions are unknowable.
This is a discipline rather than a forecast. It builds in a margin so that the deal does not depend on selling into conditions at least as favourable as those at purchase.
Assuming an exit rate lower than entry does the opposite. It requires future buyers to accept a lower yield, which is a claim about market conditions the model cannot support.
Cap rates and financing conditions move together
Capitalisation rates are influenced by the cost and availability of debt, because most buyers are borrowers. When borrowing costs rise, the price a buyer can pay for a given income falls.
They also respond to what else investors can buy. Property competes with other income-producing assets, and its pricing reflects the yield available elsewhere for comparable risk.
Because both drivers sit outside the property, an exit assumption is partly a statement about credit conditions and investor appetite rather than about the building.
The net operating income matters as much as the rate
Sale value in the model is income divided by the rate, so an optimistic income projection and an optimistic rate compound. Both errors push the same direction.
The income applied at exit should be a realistic forward figure, not a peak year. Using the best year of the hold period assumes the buyer underwrites the property generously.
Buyers also underwrite reserves, management fees and capital needs that a seller may have run lean. An exit income that ignores those adjustments will not survive a buyer's model.
Testing rather than choosing
The productive approach is to run the model across a range of exit rates and read the shape of the outcome rather than to pick a single figure.
If the deal only works within a narrow band of exit assumptions, that is information. It means the return depends on resale conditions rather than on operating the property well.
Deals that hold up across a wide band are relying on income rather than on exit pricing, which is a materially different risk profile even when the headline numbers look similar.
