Cap Rate Sensitivity Analysis for REPE Underwriting

No REPE investment committee approves a deal based on a single return number. Every IC memo includes a sensitivity table — and cap rate is almost always the most impactful variable in that table. A 50 basis point change in exit cap rate can swing equity IRR by 500+ basis points on a typical value-add deal. This guide covers how to build cap rate sensitivity analysis, why it matters more than any other assumption, and how to present it in interviews.

Why cap rate sensitivity matters most

In a typical REPE model, exit value is calculated as:

Exit Value = Forward NOI ÷ Exit Cap Rate
Exit Equity = Exit Value − Loan Payoff

Exit value is usually the largest single cash flow in the returns calculation — often 70%–90% of total equity proceeds. Because value and cap rate are inversely related, small cap rate changes produce disproportionate return swings:

| Exit Cap Rate | Exit Value ($10M Forward NOI) | Change from Base | |--------------|-------------------------------|-----------------| | 4.50% | $222.2M | +11.1% | | 5.00% | $200.0M | Base | | 5.50% | $181.8M | −9.1% | | 6.00% | $166.7M | −16.7% |

At a 5.0% base case, moving exit cap from 5.0% to 5.5% cuts value by 9% — with NOI completely unchanged. On a levered deal, that 9% value loss flows almost entirely to equity, potentially cutting IRR by 300–500 bps.

Building the sensitivity table

One-variable sensitivity (exit cap rate)

Hold all other assumptions constant. Vary exit cap rate in 25–50 bps increments:

Example: 5-year hold, $3.5M equity, $6.5M debt

| Exit Cap | Exit Value | Exit Equity | Equity Multiple | Levered IRR | |----------|-----------|-------------|-----------------|-------------| | 4.50% | $222M | $215.5M | 3.04x | 24.8% | | 4.75% | $211M | $204.5M | 2.89x | 22.1% | | 5.00% | $200M | $193.5M | 2.74x | 19.5% | | 5.25% | $190M | $183.5M | 2.60x | 17.0% | | 5.50% | $182M | $175.5M | 2.49x | 14.7% | | 5.75% | $174M | $167.5M | 2.37x | 12.5% | | 6.00% | $167M | $160.5M | 2.27x | 10.5% |

Present this as a table in every underwriting memo. Highlight the base case and show the range that covers reasonable downside.

Two-variable sensitivity (exit cap × NOI growth)

The most common IC table crosses exit cap rate with a second variable:

                    Exit Cap Rate
                4.75%    5.00%    5.25%    5.50%
NOI Growth  0%   18.2%   15.8%   13.5%   11.3%
(at exit)     3%   21.5%   19.1%   16.8%   14.5%
              5%   24.8%   22.4%   20.0%   17.6%

This shows whether the deal works under combined downside (flat NOI + wider cap) — the scenario IC cares about most.

Going-in cap vs. exit cap spread

Always show the implied spread:

Going-In Cap (on in-place NOI): 6.0%
Exit Cap (on forward NOI):      5.25%
Spread:                         −75 bps (compression)

Conservative convention: exit cap = entry cap + 25–50 bps (expansion, not compression). If your model assumes compression, you need a specific thesis (market fundamentals improving, asset stabilizing into a tighter cap tier).

Interviewers ask: "Why did you assume cap rate compression?" If you can't defend it, use flat or expanding exit cap.

Entry cap sensitivity

Exit cap gets the most attention, but entry cap (purchase price relative to in-place NOI) determines your basis:

| Entry Cap | Purchase Price ($6M NOI) | Implied Yield | |-----------|-------------------------|---------------| | 5.50% | $109.1M | Lower yield, higher price | | 6.00% | $100.0M | Base | | 6.50% | $92.3M | Higher yield, lower price | | 7.00% | $85.7M | Value-add pricing |

On a value-add deal, the going-in cap on in-place NOI is often 6.5%–8.0% (cheap on current income). The exit cap on stabilized forward NOI is 5.0%–6.0% (priced as a stabilized asset). The spread between these two caps IS the value creation from the business plan.

How to set exit cap assumptions

Don't guess — anchor to market data:

1. Current market cap rates for the asset class and submarket (CBRE, JLL, CoStar surveys)
2. Recent comparable sales (actual transaction cap rates)
3. Conservatism buffer: add 25–50 bps to current market cap for exit assumption
4. Hold period adjustment: longer hold = more uncertainty = wider assumed exit cap

Exit Cap Assumption Framework:
  Current market cap for stabilized asset:     5.25%
  Conservatism buffer:                         +50 bps
  Hold period uncertainty (5-year hold):       +25 bps
  Base case exit cap:                          6.00%
  Sensitivity range:                           5.50% – 6.50%

Presenting sensitivity in interviews

When asked "what's the most sensitive assumption?" — the answer is almost always exit cap rate. Follow up with:

1. Show you've built a sensitivity table (even verbally: "at 5.5% exit cap, IRR drops from 19% to 15%")
2. Explain your exit cap assumption (market data + conservatism buffer)
3. Identify the breakeven exit cap (where IRR hits your hurdle rate)
4. Compare to current market caps (is your assumption above or below market?)

Breakeven analysis:

Hurdle IRR: 15%
Breakeven Exit Cap: ~5.75% (the cap rate at which levered IRR = 15%)
Current market caps for stabilized comps: 5.25%–5.50%
Margin of safety: 25–50 bps above current market

This tells IC: "We can be wrong on exit cap by 25–50 bps and still hit our hurdle."

Common interview questions

"What happens if exit cap expands 50 bps?" Calculate it. On a typical deal, 50 bps cap expansion reduces exit value by ~9%, cutting levered IRR by 300–500 bps. State the specific numbers from your model.

"Why not just use the current market cap as your exit cap?" Current market cap reflects today's pricing. At exit (3–5 years from now), market conditions may differ. Adding a conservatism buffer protects against cap rate expansion, which is the more common risk over a multi-year hold.

"Going-in cap vs. exit cap — which matters more for returns?" Both matter, but exit cap typically has more impact because exit value is the largest cash flow and small cap rate changes produce large value swings. Entry cap determines your basis and going-in yield; exit cap determines your profit.

"How do you build a two-way sensitivity table?" Cross exit cap rate (rows) with a second variable — usually NOI growth or hold period — and show levered IRR at each intersection. The base case sits in the center; downside scenarios fill the corners.

The takeaway

Cap rate sensitivity isn't a formatting exercise — it's the core risk analysis in REPE underwriting. Every assumption in your model could be wrong; cap rate sensitivity shows how wrong exit cap can be before the deal fails. Build the table on every model, know your breakeven exit cap, and be ready to walk through the numbers in any interview. IC committees and REPE interviewers are testing the same thing: do you understand that exit cap is the assumption that matters most?