If exit cap rate rises while NOI remains constant at year 7, what happens to the investment's IRR, assuming purchase price unchanged?

• A. IRR increases due to higher cap rate.
• B. IRR remains the same.
• C. IRR decreases because terminal value declines.
• D. IRR becomes negative only if cap rate > 20%.

Answer: (C)

The key idea is that IRR is driven by all cash flows you actually receive, including the sale at the end of the holding period. With NOI in year 7 held constant and the purchase price unchanged, the only thing that changes when the exit cap rate moves is the terminal value at sale. The terminal value in these real estate calculations is typically NOI7 divided by the exit cap rate. If the cap rate rises, the exit price falls. That lower terminal cash inflow reduces the total returns the investment can generate, which lowers the IRR.

For example, if NOI7 is fixed and the exit cap rate increases, the sale proceeds shrink, even though the initial outlay is the same. That drop in the final cash flow drags the internal rate of return downward. It wouldn’t cause the IRR to rise, and it isn’t correct to claim it remains unchanged. While in theory a very high cap rate could push IRR negative, there isn’t a fixed threshold like a specific cap rate that guarantees negativity in this setup; the correct takeaway is that IRR decreases because terminal value declines as the exit cap rate rises.