multi family exit cap rates

[Jason Malabute]

It is becoming more popular to underwrite deal and calculate the terminal cap rate by taking the current market cap rate and add .1% for every year it is held to make deals work. For example, if the market cap is 5.5% and you plan to hold the property for 5 years then the exit cap would be 6%. My question is under that model what would you do if we go into a downturn and cap rates decompresses by more than the .5% projected or if the cap rates decompressed by .5% before the 5 years are up?

[Nick B.]

Exit cap rate is a guess. Nobody knows what it is going to be. 

It may make sense to price your exit over a range of cap rates. E.g., if today's rate is 5%, then price your exit between 5.5% and 6.5% (or 7.5%) in .1% increments. Then you'll see at what cap rate and holding period you start losing money.