What is the 'Terminal Capitalization Rate'

The terminal capitalization rate is the rate used to estimate the resale value of a property at the end of the holding period. The expected net operating income (NOI) per year is divided by the terminal cap rate (expressed as a percentage) to get the terminal value. Terminal capitalization rates are estimated based on comparable transaction data or what is believed to be appropriate for a particular property's location and attributes.

BREAKING DOWN 'Terminal Capitalization Rate'

The terminal capitalization rate is also known as an exit rate. The going-in rate for a property is projected first-year NOI divided by the purchase price of the property. The terminal capitalization rate is the projected NOI of the last year (or the exit year) divided by the sale price. If this rate is lower than the going-in rate, it usually means that the property investment was profitable.

Example of the Terminal Capitalization Rate

An investor buys a fully occupied property for $100 million. First-year NOI is estimated at $5.0 million. The going-in rate is therefore 5.0%. Seven years later, the investor believes that the terminal capitalization rate is approximately 4.0%. Last-year NOI, which has taken into account rent escalation along the way, is projected at $5.5 million (again, assuming full occupancy). The resale value is estimated at $137.5 million ($5.5 million in NOI divided by the 4.0% terminal capitalization, or exit, rate).

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