Understanding Net Operating Income by:Chris Goulart
When dealing with commercial property, it is very important to know and understand a number of commercial lending terms
. We have put together a full glossary of commercial loan terms for you, with all of the following terms defined, among others:
DCRDeferred maintenance accountOperating expensesLTVGross leaseEGRDebt ServiceAPR
Today, however, we are going to explore one of the most basic terms to aid in the evaluation process of an income producing commercial property, NOI. Net operating income, or NOI, is probably the single most basic and important concept to understand, as many calculations relating to the financial strength of a commercial property are tied to this concept.
When evaluating income on a commercial property, there are two basic premises to deal with. These are contract rent and market rent. Market rent is the amount you would expect to be able to rent a space for on the open market at the time of evaluation. Contract rent, on the other hand, is the actual rent collected. Typically, market rent will be found through rental surveys, often times done by an appraiser.
When compiling your numbers, you will be using the market rent number for any vacant space in the commercial property. For the space that is currently rented, use the actual or contract rent. When putting these numbers together, you may note that if your contract rent is less than market, your commercial property valuation could suffer.
When making commercial loans, the basic value system used is the income approach, which requires the NOI to be calculated. In order to calculate this, once you have your income numbers, you will then need to find the total operating expenses. Operating expenses are just that, all of the expenses and allowances associated with your commercial property. Mortgage expenses are not included in this .
When figuring the operating expenses, you will have two types of expenses. These are fixed expenses and variable expenses.
Fixed expenses are those costs that stay the same no matter how high your vacancy might be. Real estate taxes are a good example of fixed expenses. Variable expenses are those expenses that do vary depending on the vacancy factor. A good example of a variable expense is utilities. In addition, you will usually include a replacement reserve in these operating expenses.
Once your operating expenses are together, you need to find your effective gross income. This is the income from the property after taking into account a vacancy factor. Take this number and subtract your operating expenses and that will give you the NOI of the property. When dealing with commercial real estate transactions, the net operating income is important to know, and you should feel comfortable calculating it.
Once you have your net operating income number, you can use it in a number of ways. When lenders make Commercial loans, value is loosely based on the net operating income. You can use a combination of cap rate and the NOI to find an implied value for a commercial property. If your net operating income is 80,000 and the cap rate for your area is 7%, your implied value for the subject property would be just over $1.1m.
Commercial lenders will also look at the pretax cash flow of a property, the debt coverage ratio of a property and the annual debt service of a property. These all rely on the NOI number, making NOI a very important number to be comfortable calculating.
About the author
Chris Goulart is a mortgage professional specializing in commercial loans. you can find a lot more information about commercial loans at his website:
http://www.acalending.comhttp://www.articlecity.com/articles/business_and_finance/article_10477.shtml
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