Rick M. Bean of Rose City Commercial Real Estate writes insightful articles about real estate investing. HIs post about the basics of investing is particularly valuable:
As there is a mix of investment sophistication levels on this site I have opted to interject a review of the basics. For you institutional investors…hang on we’ll have some information that we think you’ll find valuable in…later posts.
What is NOI?: Net Operating income
What does it measure?: Measures the revenue generating capacity from operations.
When is it important?: Two times: When you is sellin’…and when you aint. On a more serious note, NOI is the source of payment for debt service, and cash flow distributions to the owners.
Why it’s important: It provides a way to measure the revenue producing capabilities of an asset excluding debt service considerations.
What’s the formula?: Current Revenue – Current Expenses (Exclude debt service, capital expenses.)
Example: Current Revenue, June 2009: $100,000.
Current Expenses, June 2009: $ 35,000.
NOI, June 2009 $65,000.
What is a Cap Rate?
The capitalization rate is what the yield as a percentage of the initial investment would be in year one if you acquired the property all cash.
Why it is important: First “sniff test” investors use to check out an available commercial property.
What is the formula? NOI/Sale Price = Cap Rate
Example: $65,000/$812,500= 8%.
What is NOI Multiplier?
How much each dollar of NOI would contribute to value if property was for sale.
Why we care: Knowing how much each dollar on NOI is worth helps us evaluate the impact of incremental increases in revenue and expense. (Great for rehab/repositioning!)
What’s the formula? Sale Price/NOI = NOI Multiplier
Example: $812,500/$65,000= 12.50 (Each dollar of NOI creates $12.50 of value.)
NOI, CAP, and NOI Multiplier Problems
A Portland Multifamily investment Property X had the following revenues in 2008:
• Rent $122,500.
• Extraordinary gain: harvest lumber on property $25,000.
• Pet rent $300.
Property X had the paid the following in 2008:
• Utilities, taxes, management fees, etc. $48,000.
• Cap Ex: Completely rebuild lower parking lot $19,000.
• Re-stripe upper parking lot $125.
QUESTIONS 1 & 2 are based on the information above.
1. What was NOI? ANSWER: $74,675 Note: The lumber revenue and parking lot expense were not operating related and were thus excluded from NOI.
2. What is the asset worth if we assume a 6.9 Cap% ? ANSWER: $74,675 / .069 = $1,082,246
QUESTIONS 3 – 4 are based on repositioning an 18 unit property we are buying for $1,200,000 at an 8 cap with a 5.9 % loan. Current Annual NOI is $96,000:
3. How much is each dollar of NOI worth? ANSWER: $1,200,000/$96,000 = $12.50.
4. How much more would the property be worth if we could raise the rents in 10 of the units $10/month? (Assume that a year has 12 months, all the units are increased at the same time for the full year…and that we could do this without increasing expenses…without any change in turnover.) Answer: 10 units X $10 X 12 months equals a $1,200 increase in Annual NOI. Multiply by $12.50 = $15,000 increase in value!