Four break-even exit yields sit in every property model, hundreds of basis points apart, and the comfortable one is rarely the one that matters.
Solve for the exit yield at which the return just meets the target, holding every other input fixed: in Excel, Goal Seek the IRR cell to the target by changing the exit yield. On an illustrative 17,000,000 purchase with a 6.50 per cent base exit yield, the unlevered break-even for a 7 per cent IRR is 6.71 per cent, only 21 basis points of headroom, while the yield at which the investor merely gets its money back is 10.25 per cent.
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 →
Every property model has a break-even exit yield, and most committee papers quote the wrong one. There are at least four, depending on whether the return is levered and whether break-even means hitting the target or only recovering the capital. They sit hundreds of basis points apart, and the comfortable one is rarely the one that matters.
| Input | Value |
|---|---|
| Purchase price | 17,000,000 |
| Acquisition costs | 4.0% |
| Total cost | 17,680,000 |
| Net operating income, year 1 | 1,100,000 |
| Income growth a year | 2.5% |
| Net initial yield on price | 6.47% |
| Base exit yield, on year 6 income | 6.50% |
| Sale costs | 2% |
| Loan: 55% of price, interest only at 4.75% | 9,350,000 |
| Targets: unlevered / levered IRR | 7% / 10% |
The exit is priced on forward income, year 6 NOI of 1,244,549, so the base exit value is 1,244,549 ÷ 6.50% = 19,146,908 gross and 18,763,970 after sale costs. The base case returns 7.57 per cent unlevered at a 1.39 multiple, and 10.59 per cent levered at 1.56 on 8,330,000 of equity.
Exit value = NOIyear 6 ÷ exit yield × (1 − sale costs)
Break-even exit yield: the exit yield at which IRR(cash flows) = target
In Excel: Data, What-If Analysis, Goal Seek. Set cell IRR_unlev to value 0.07 by changing cell ExitYield. For a live answer instead of a pasted one, solve it with a small bisection table or a data table on the exit yield.
The IRR falls continuously as the exit yield rises, so there is exactly one break-even for each target. Running Goal Seek four times gives the four numbers that belong on the page.
| Break-even | Exit yield | Headroom, bp | Exit value | Fall in value |
|---|---|---|---|---|
| Unlevered IRR at 7% target | 6.71% | 21 | 18,539,961 | 3.2% |
| Unlevered IRR at 0% | 10.25% | 375 | 12,140,856 | 36.6% |
| Levered IRR at 10% target | 6.61% | 11 | 18,826,683 | 1.7% |
| Levered IRR at 0% | 8.64% | 214 | 14,406,800 | 24.8% |
Read the pairs. Unlevered, the investor gets its money back up to a 10.25 per cent exit yield, 375 basis points of headroom, which sounds like a fortress. It misses its 7 per cent target at 6.71 per cent, 21 basis points out: a 3.2 per cent fall in exit value. The money-back headroom is 18 times the target headroom. Levered, the same contrast is 214 against 11 basis points, a ratio of 19, because the loan absorbs none of the value fall and the equity absorbs all of it.
The deal is priced to break even against its target at almost exactly the entry yield. The net initial yield is 6.47 per cent and the unlevered break-even is 6.71, 24 basis points apart. Put plainly: the 7 per cent case requires the market to pay at exit roughly what this buyer paid at entry, and the sale and acquisition costs have to be earned by income growth.
| Case | Base IRR | Break-even exit yield | Headroom, bp |
|---|---|---|---|
| Income growth 0.0% | 5.10% | 5.84% | −66 |
| Income growth 1.5% | 6.58% | 6.35% | −15 |
| Income growth 2.5% | 7.57% | 6.71% | 21 |
| Income growth 3.5% | 8.56% | 7.10% | 60 |
| Hold 3 years | 6.69% | 6.44% | −6 |
| Hold 10 years | 8.23% | 7.67% | 117 |
Each point of income growth moves the break-even by roughly 34 to 38 basis points, so the exit yield and the growth rate are not independent assumptions: the deal's headroom is largely a growth assumption in disguise. A longer hold widens the headroom because the exit carries less of the return, which is also why a short hold is the most exposed to the exit yield.
The common mistake is to report the money-back break-even as the headroom. "The exit yield could move out 375 basis points before we lose money" is true and nearly irrelevant: no investment committee approved this deal to earn zero. The question the committee is asking is how far the exit yield can move before the deal fails the return it was approved on, and here the answer is 21 basis points unlevered and 11 levered. Present the target break-even first, express it as a fall in value as well as in basis points, and show the levered figure beside the unlevered one.
Two checks on the model itself. Recalculate the exit value at the break-even yield by hand: 1,244,549 ÷ 6.71% should reproduce 18,539,961 to within rounding. And confirm the levered money-back break-even sits inside the unlevered one, 8.64 against 10.25 per cent here. With any loan that carries interest it must, because the debt is repaid ahead of the equity; if it does not, the debt is wired into the model wrongly.
A break-even exit yield is only meaningful against a stated target. On this deal the useful number is 6.71 per cent, 21 basis points of headroom, not the 10.25 per cent at which the capital merely comes back. The free companion workbooks for the book build the same front page for a complete model, with its break-evens, and a related article shows why stressing exit yield and income together is worse than stressing them one at a time.
It is the exit yield, or cap rate, at which a deal's return exactly equals a stated threshold, usually the target IRR. On an illustrative five-year hold with a 6.50 per cent base exit yield, the break-even for a 7 per cent unlevered IRR is 6.71 per cent. Without naming the target, the figure has no meaning.
Use Goal Seek: set the IRR cell to the target, for example 0.07, by changing the exit yield cell. The IRR falls steadily as the exit yield rises, so each target has one answer. Here it returns 6.71 per cent for 7 per cent unlevered and 6.61 per cent for a 10 per cent levered target.
The loan is repaid in full whatever the sale price, so every fall in value lands on the equity. On the illustrative deal the levered 10 per cent target allows 11 basis points of exit yield movement, a 1.7 per cent fall in value, against 21 basis points unlevered. Even the levered money-back headroom, 214 basis points, is well inside the unlevered 375.
Chapter 15 of Real Estate Financial Modeling sets out the break-even numbers a sensitivity section owes a committee; the free companion files rebuild them for a complete model. 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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