Net Operating Income
Investors don’t usually decide to buy properties based on “curb appeal” or aesthetics—more likely, they buy the income stream from the property. Commercial real estate value is based on numbers and ratios, and the most important number to know is the net operating income for a property. The net operating income (NOI) is the single most important number used to determine value and financing options.
Net operating income is the gross income minus vacancy loss and operating expenses. It is not to be confused with cash flow (unless there is no debt on a property), since debt service is not considered part of operating expenses. In the same way, capital improvements are not considered an operating expense, nor is depreciation considered an operating expense (depreciation is considered a non-cash deductible expense and plays a role in determining taxable income—more on that later).
A simple way to calculate NOI is to use the following formula:
Scheduled Gross Income + Other Income (Laundry, Garage, etc.)
Less: Vacancy Factor = Effective Gross Income
Less: Operating Expenses = Net Operating Income
A quick rule-of-thumb that lenders and appraisers use to determine NOI for apartment properties in Southern California is to use a 5% vacancy factor and 35% operating expense ratio. The operating expense ratio is derived from the Effective Gross Income.
For example, let’s say an apartment property has an annual scheduled gross income of $100,000 andno other income. Using the rule-of-thumb outlined above:
|Schedule Gross Income||$100,000|
|Less: Vacancy @ 5%||-5,000|
|= Effective Gross income (EGI)||$95,000|
|Less: Operating Expenses @ 35% of EGI||-$33,250|
|= Net Operating Income (NOI)||$61,750|
I wanted to take a moment to formally thank you for the time and effort you and your team have spent working on our behalf. After having helped us with so many Apartment loans-and always with the best terms- I can say with honesty that your work is not just outstanding in terms of content, but also through your kind demeanor in how you present it. We look forward to working with ALB Commercial Capital through you in the future for all our commercial real estate needs.”