Why is understanding Net Operating Income (NOI) important in Commercial Real Estate?
In order to fully understand an investment real estate transaction it is important to understand net operation income and what it means to your client.
The number one thing to remember is that net operation income is unique to the property, rather than to the investor.
Therefore, the net operating income figure excludes any financing or tax costs incurred by the current owner.
NOI is best served by the use of historical financial data. Most banks will want to see your three most recent complete Federal Income Tax Returns and will be closely examining the Schedule C's for profitability and financial trends.
The Net Operating Formula:
Potential Rent Income-Historical Vacancies and Credit Losses=Effective Rental Income
Effective Rental Income + Other Income=Gross Operating Income
Gross Operating Income - Operating Expenses= Net Operating Income
Net Operating Income measures the ability of a property to produce an income stream from operations.
This income stream will be used by the bank that is looking at the financing package to determine how much they can lend toward the project.
A typical commercial loan could be 25% down, amortized for twenty years with a balloon at the end of ten years and a repricing opportunity for the bank at the end of five years. They will take a hard look at the debt service ratio which tells them how much cash is left over after all the operating expenses are paid and their loan is serviced. They would like to see a 20% margin on the "back end". It is hard to get to that number but makes their lending approval decision much easier if it is there.
Develop a good relationship with several commercial bankers in your market. Go to lunch with them from time to time to keep abreast of what their rates are doing and what they are seeing in your market. It will pay dividends for both of you.
It is a good time to be a Commercial Realtor®. May all of your deals be good ones.