NOI Defined by:Chris Goulart
When dealing with commercial loans and commercial real estate
, it is crucial to not only know, but also understand many terms. We have put together a full glossary of commercial loan terms for you, with all of the following terms defined, among others:
AnchorEGITriple netEstoppel certificatesFixed costsStabilized occupancyContract rentFMV
Today, however, we are going to look at one of the most crucial terms to help in evaluating a commercial property, net operating income. 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 basically what you could rent your space for on the open market. This can be found by doing a market survey. Contract rent, on the other hand, is what the space is actually being rented for now
When putting together your spreadsheet, you will be using the market rent number for your vacant space in the commercial property. For all space that is currently rented out, you will 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. Once you have the income for the property together, you will then need to find the total operating expenses so you can find the NOI, or net operating income. Operating expenses are exactly what they sound like, all of the expenses and allowances associated with your commercial property. Debt service is not included in this figure.
When calculating your 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 expenses that do fluctuate depending on the vacancy factor. A good example of a variable expense is payroll. In addition, you will usually include a replacement reserve in your 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. Subtract your operating expenses from your effective gross income and that will give you the net operating income of your property. When dealing with commercial loans or commercial real estate, the net operating income is important to know, as it can really tell you a lot about the health of a property.
You can use the NOI of a property to look at a number of aspects related to the property. 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 $50,000, and the cap rate in the area is 8%, the implied value of that property would be $625,000.
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 net operating income number, making net operating income 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.com
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