When may a terminal cap rate be lower than a “going in” cap rate?
Answer Hi Vicki – In short, terminal cap rate is higher than going in cap rate if income is stabilized and value goes up, lower if income and/or value goes down. Since the going in cap rate is a real number (based upon the actual purchase price and first year NOI) and the terminal cap rate is a theoretical estimate based upon discounted cashflows at some number of years in the future, it should be easy to break down the elements of the equation to see which ones move the terminal cap rate up or down. It is frequently taught that no one is going to buy a building with a terminal cap rate that is lower than the going in cap rate because no one wants to buy something today that they can’t sell for a higher price in 10 years. That makes sense, though many investors look outside the theoretical box to find more value in the property, such as tearing down a small building at a prime location after “X” number of years and replacing it with a big building. Putting new improvements (buildings)
