Terminal Value

Terminal value estimates what an asset will be worth when the projection period ends. In real estate it is the sale price assumed in a discounted cash flow model, usually found by dividing the following year's NOI by an exit cap rate, also called a terminal or reversion cap rate.

If the example property's NOI grows 3% a year, year six NOI is about $34,500. At a 6.25% exit cap rate the year-five sale price is about $552,000. The terminal value often makes up most of the total return in a five to ten year discounted cash flow analysis.

Analysts usually set the exit cap rate at or above the going-in rate to allow for the building aging and for rates possibly being higher. A model that assumes a lower exit cap rate than today's is betting on the market, not on the property.