One row reference in the exit formula decides it, and it should match the convention the entry price was quoted on.
Apply the exit cap rate to forward NOI, the income of the first year after the sale, so that the exit is valued on the same basis as the entry price. On an illustrative five-year hold with 3 per cent income growth, forward NOI gives an exit value of 18,548,385 and an 8.16 per cent IRR; trailing NOI gives 18,008,141 and 7.63 per cent, 53 basis points lower for a reason nobody chose.
Worked in full in Real Estate Financial Modeling by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
The choice is made by one cell reference in the exit formula, and it is often made by accident: the model has five annual columns, the exit sits in year 5, and the formula picks up year 5's NOI because it is next to it. Buyers do not price that way. They pay for the income they will receive, which is year 6's.
| Input | Value |
|---|---|
| Purchase price | 16,000,000 |
| Acquisition costs, 3% | 480,000 |
| NOI, year 1 | 1,000,000 |
| Going-in cap rate on year-1 (forward) NOI | 6.25% |
| NOI growth a year | 3% |
| Exit cap rate, equal to entry | 6.25% |
| Sale costs | 2% |
| NOI, year 5 / year 6 | 1,125,509 / 1,159,274 |
Exit value (forward) = NOIhold + 1 ÷ exit cap
Exit value (trailing) = NOIhold ÷ exit cap
Equivalent forward cap of a trailing exit = exit cap × (1 + g)
In Excel, extend the NOI row one column beyond the hold and reference it: =OFFSET(NOI_Row_Start, 0, Hold)/Exit_Cap, or simply a year-6 column that exists only to feed the exit. Then the hold can change without the reference breaking.
| Convention | NOI capitalised | Gross exit | Net of sale costs | IRR | Multiple |
|---|---|---|---|---|---|
| Forward, year 6 | 1,159,274 | 18,548,385 | 18,177,417 | 8.16% | 1.43x |
| Trailing, year 5 | 1,125,509 | 18,008,141 | 17,647,978 | 7.63% | 1.39x |
The gap is one year of growth: 540,244, or 3.0 per cent of value. Put differently, a trailing exit at 6.25 per cent is the same as a forward exit at 6.25% × 1.03 = 6.44 per cent. The model that uses trailing NOI has quietly assumed 19 basis points of yield expansion while its assumptions page says entry and exit yields are equal.
The rule is consistency, not a preference for one number. This deal was bought at 6.25 per cent on forward NOI, the usual quotation. Exiting at 6.25 per cent on forward NOI is a genuinely flat yield assumption. If the entry had been quoted on trailing income, the same price would be a 6.07 per cent trailing yield, and the honest comparison would be trailing against trailing. Mixing them, forward at entry and trailing at exit, builds in a cap rate movement of the size of the growth rate.
| Case | Forward IRR | Trailing IRR | Gap, bp |
|---|---|---|---|
| Hold 3 years, growth 3% | 7.47% | 6.54% | 93 |
| Hold 5 years, growth 3% | 8.16% | 7.63% | 53 |
| Hold 7 years, growth 3% | 8.46% | 8.10% | 36 |
| Hold 10 years, growth 3% | 8.68% | 8.45% | 23 |
| Hold 5 years, growth 0% | 5.19% | 5.19% | 0 |
| Hold 5 years, growth 2% | 7.17% | 6.82% | 35 |
| Hold 5 years, growth 5% | 10.14% | 9.25% | 89 |
The convention matters most on short holds and growing income, exactly the value-add deals where the exit carries most of the return. At zero growth the two are identical, which is why the error survives in models first built for flat, long-let income.
Forward NOI has its own trap. Suppose the main lease expires early in year 6 and the model shows downtime and rent-free that cut year-6 NOI by 20 per cent, to 927,419. Capitalised mechanically, the exit value falls to 14,838,708 and the IRR to 4.27 per cent. But the cash lost is a one-off 231,855. Capping it at 6.25 per cent turns it into a loss of 3,709,677 of value, 16.0 times the cash, as if the void lasted for ever.
A buyer would price stabilised forward NOI and deduct the one-off cost of the re-letting: 1,159,274 ÷ 6.25% − 231,855 = 18,316,530, an IRR of 7.94 per cent (the deduction is left undiscounted for simplicity; discounting it by a year would barely move the figure). The mechanical figure overstates the hit by 3,477,822. The right reference is stabilised forward NOI, with the lease event shown as a separate deduction, and the leasing costs added to it in a full model.
A check worth adding. Put the exit NOI, its year, and the equivalent forward cap rate on the summary page beside the exit value. If the exit NOI is not from the year after the sale, or differs from the stabilised run rate by more than the growth rate, the reader should see it without opening the cash flow.
The common mistake is to treat the exit year's own NOI as the natural thing to capitalise because it sits in the last column. It understates the exit by one year of growth and makes the model look conservative for an unstated reason. The second mistake, in the opposite direction, is to fix the reference to year 6 and never look at what year 6 contains. Both are solved by making the exit NOI an explicit, labelled input drawn from a stabilised forward year. How much headroom the exit yield then has is the subject of the break-even exit yield.
Capitalise forward, stabilised NOI at the exit, on the same basis as the entry price. On this deal the trailing convention costs 53 basis points of IRR by assuming a 19 basis point yield expansion no one wrote down, and a mechanically capitalised lease event costs far more. The free workbooks for this book include a complete property model where the exit can be tested line by line.
Usually year 6, the forward NOI the buyer will earn, because buyers price on next year's income and the entry cap was quoted the same way. On an illustrative deal, year-6 NOI of 1,159,274 at 6.25 per cent gives 18,548,385; year-5 NOI gives 18,008,141, 3.0 per cent less, which is exactly one year of growth.
Do not capitalise the dip. A buyer prices stabilised forward NOI and deducts the one-off cost of the re-letting. On the illustrative deal, a 20 per cent loss of year-6 income is 231,855 of cash, but capitalised at 6.25 per cent it would cut exit value by 3,709,677, 16.0 times the loss, and the IRR from 8.16 to 4.27 per cent.
It is lower, but it is not a deliberate margin. A trailing exit at 6.25 per cent equals a forward exit at 6.44 per cent, a hidden 19 basis point yield expansion whose size depends on the growth rate. State the exit yield on forward NOI and widen it explicitly if prudence is intended.
Chapter 15 of Real Estate Financial Modeling calls the exit yield the assumption that carries the answer; the free Meridian House model lets you change it and watch what moves. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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