Question

An industrial property recently sold for $5,500,000. First-year NOI is $440,000. NOI is expected to increase annually by 4% over the next decade. The expected holding period is 7 years.
1. What would terminal cap rate be appropriate?
2. what is the relationship between today's cap rate and the going out cap rate?
3. In addition to capitalizing income, there is a second method to estimate terminal value describe the method and provide a numerical example.

Answer 1

Answer-1

Using Gordon growth model, we find the capitalisation rate as below

Terminal value= Income * (1+g) k-g	where, k=capitalisation rate & g = growth rate(4%) Income = 440,000 terminal value = 5,500,000
5,500,000=	440,000*(1+g) k-g
5,500,000*(k-g)   =	457,600
k-g=	457,600/5,500,000
k-0.04                  =	0.0832
k                          =	0.0832+0.04
k                          =	0.1232
or k                    =	12.32%

Using th gordon growth model, we find capitalisation rate as 12.32%

Answer2

Ideally the going-out capitalisation rate or terminal capitalisation rate should be greater than or equal to the going-in capitalisation rate

Answer 3

Other than capitalisation of Income model, to estimate a terminal value, discounted cash flow model is used. A discounted cash flow model is prepared by estimating the net income (Gross Rent-operating expenses), discount rate, vacancy rate, tax rate and then the same is used to calculate the net income and terminal value over the holding period.