NOI (Net Operating Income): A “Must Read” for all Real Estate Owners
What is NOI?
At JLD Apartment Consulting, we want for our customers to understand the importance of Net Operating Income. For commercial or residential real estate properties, the general definition of Net Operating Income is the difference from the Gross Operating Income received from rents and other miscellaneous income after subtracting all the Normal Operating Expenses such as maintenance, management expenses, supplies, legal and accounting, leasing fees, utilities, property and liability insurance, property taxes, security, etc.
Real Estate Owners and Operators of income properties should make take care to include ALL normal expenses related to the actual operation of their apartment properties or else this number can mislead lenders, buyers and appraisers as this is an important, but not the only, method for evaluating the worth of the property. Because NOI can vary widely from month to month, the calculation of this important number over a period of a year is the best indicator of how well the property is performing.
Not included in Normal Operating Expenses: Capital Expenditures: These are generally major repair or replacement items such as partial or total roof replacement, major renovations, etc. Normally, these are repairs or purchases that have a usable life in excess of fifteen years or longer. Also not included in the NOI calculation are: mortgage principal and interest, amortization of loan points, depreciation, etc. These areas are unique to the owner but not to the operation of the property. (Note: some entities credit the mortgage principal as income.)
Why is it important?
There are three methods of valuating an Income Producing Property: Often, the industry accepted value of an income property is the average of these methods, with some weighting factors.
Market Value is the value established by the value of other comparable properties in the same regional area and is usually based on recent sales of these properties.
Replacement Value is the estimated cost of reconstructing this property in the same market area with some adjustments for age and obsolescence.
Income Method: This is where The Net Operating Income is most important. It uses what is called a Cap Rate that is short for Capitalization Rate, or return on investment. The Cap Rate can determine the value using the NOI. Let’s say that investors want to achieve a rate of return of 8.5% on their investment. The price is determined by dividing the NOI by the cap rate. For example, let’s say the annual NOI for a given property is $250,000.
Its Income Value is: $250,000 divided by .085 = $ 2,941,176.40 or approx: $2,941,176
Just a five (5.0%) reduction in annual expenses increases this property’s value to $ 3,088,235. A whopping increase of $147,060! This is why your expenses really matter. What is your NOI?
Contact with JLD Apartment Consulting Services in Austin, Texas and learn more about NOI and it’s importance today!