The Exit Cap Trap: Never Assume You Can Sell at a 5% Cap Rate

Between 2020 and 2022, thousands of commercial real estate syndicators acquired multifamily buildings at aggressive 3.8% and 4.2% cap rates. In their investor pitch decks, they modeled selling the property five years later at a 4.0% cap rate.

When interest rates rose, market cap rates expanded to 5.75% and 6.25%.

That single shift caused a catastrophe. A property generating $600,000 in net operating income is worth $15 million at a 4.0% cap rate. At a 6.0% cap rate, that exact same property is worth $10 million. In one stroke, $5 million in equity disappeared—even though the building was completely full.

The Golden Rule of Conservative Underwriting

Whenever you evaluate a real estate acquisition, assume the world will be harder when you sell than when you bought:

• Add At Least 50 Basis Points to Exit Cap: If you purchase a property at a 6.0% cap rate today, your 5-year financial model must assume an exit cap rate of at least 6.5%.
• Demand Positive Unlevered Returns: The deal must generate acceptable cash returns from ongoing monthly operations without relying on terminal multiple expansion.
• Lock In Fixed Debt: Floating-rate bridge debt is poison during cap rate expansions. Secure fixed agency debt for 7 to 10 years.

If a real estate deal only works when the next buyer pays a higher valuation multiple than you did, you aren't investing. You are gambling.