Why is the terminal capitalization rate usually set above today's rate?
Correct Answer
C) The building will be older and its remaining income shorter
Why this is correct: The 'terminal capitalization rate usually set above today's rate' because 'the building will be older and its remaining income shorter'—reflecting increased risk and diminished remaining economic life. Why the other choices are wrong: 'The discounting mathematics itself requires such a spread' is not inherently true; the relationship depends on assumptions. 'Terminal rates must include the future costs of the sale' is incorrect; sale costs are typically deducted from the reversion proceeds, not baked into the cap rate. 'Lenders impose the higher exit figure in their covenants' is not a general principle; terminal rates are market-derived. Exam tip: A terminal cap rate lower than the going-in rate implies expected market improvement, which should be explicitly justified.
Why This Is the Correct Answer
Why this is correct: The 'terminal capitalization rate usually set above today's rate' because 'the building will be older and its remaining income shorter'—reflecting increased risk and diminished remaining economic life. Why the other choices are wrong: 'The discounting mathematics itself requires such a spread' is not inherently true; the relationship depends on assumptions. 'Terminal rates must include the future costs of the sale' is incorrect; sale costs are typically deducted from the reversion proceeds, not baked into the cap rate. 'Lenders impose the higher exit figure in their covenants' is not a general principle; terminal rates are market-derived. Exam tip: A terminal cap rate lower than the going-in rate implies expected market improvement, which should be explicitly justified.
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