|
NOI - Net Operating
Income - APOD
A property's NOI is a necessary part of
almost any formula used to determine the value of investment property so it
must be as close to a real number as possible. The present value of well
maintained income producing real estate is always some multiple of it's Net
Operating Income. For example: if the present value of investment capital is
10%, a property with an NOI of $6,820 might be worth about $68,820 to a new
investor.
NOI is determined by subtracting all
operating expenses from gross rents. Professional investors and appraisers
usually use an APOD form (Annual Property Operating Data) to determine NOI.
Sellers and their agents, typically arrive at the advertised NOI by using
gross scheduled rents and ignoring deductions for such things as
uncollected rent, vacancies, redecorating, adjustments for deferred
maintenance and management costs.
Operating expenses must include almost all of
the costs of owning, managing and maintaining a property, except
depreciation and debt service (principal and interest payments).
They are generally broken down into the
following seven categories:
Vacancy
and Collection Losses: A rental property will not be occupied 100%
of the time and landlords do not collect 100% of the money even when it is
occupied. Some realistic allowance must be made for these losses. Real
estate appraisers will often use a number between 5% and 10% of gross
income. Professional investors ask to examine a seller's Schedule E from the
previous two or three year's tax returns. If that isn't possible, they may
research the market, select competing properties, and try to determine
what real vacancy and collection losses are likely to be.
Capital Reserves:
Reserves for major replacement are often overlooked when calculating an NOI.
It is the money that should be set aside each month to cover the cost of
replacing such things as roofs, heating and air conditioning, parking lots
or structures. A capital reserve account operates similar to the escrow or
impound account for property taxes and insurance that is often required by
lenders. The applicable percentage of gross revenue that should be set
aside depends primarily on the age and condition of a property.
Property Management:
Many small property owners do not consider management expense when they
value property because they intend to manage it themselves. That concept is
not realistic for many reasons, and should never be used to help justify
paying too much for an investment property. A buyer should ask themselves if
they intend to continue working for free for the next owner, or how they
will deal with an injury or illness that forces them to hire a manager.
Maintenance: The costs of properly maintaining a property are almost
always underestimated by small property owners and novice investors. The
owner may do much of the work without charging his time to the property, and
a new investor may believe he can do the same thing. You think you can
replace a toilet control assembly for less than $10 if you do it yourself,
while a licensed plumber would likely charge $75 or more. But, when you
consider your time; not just actually doing the work, but the trip to verify
the problem, the time picking up the part and driving to and from the job,
how much is it really worth? Don't forget the cost of operating and insuring
your vehicle or the purchase of tools. When considering the cost of
maintenance, you must include the cost paying yourself, or someone else at
market rates, to arrive at a realistic NOI.
Note: the APOD form has maintenance and
repair broken out in many different categories so that an experienced
investor or property manager can easily spot potential deferred
maintenance problems and what may be missing or misinformation.
Utilities: If any are paid by the owner, they are a deductible
operating expense.
Taxes:
Property taxes are a NOI deduction, income taxes are not.
Insurance: Both the normal property insurance premiums and any
additional liability umbrellas you may carry are included in operating
expenses.
The following is a simplified APOD
| Gross
rents |
|
|
$12,000 |
|
Operating Expense |
Estimated |
Actual |
|
| Vacancy and
Collection, 5% |
600 |
|
|
| Capital
Reserves, 3% |
360 |
|
|
| Management,
5% |
600 |
|
|
| Maintenance,
7% |
840 |
|
|
| Taxes |
2,400 |
|
|
| Insurance |
380 |
|
|
|
Total Operating Expense |
$5,180 |
|
|
|
NOI |
|
|
$6,820 |
Property Value: NOI x 10 = $68,200.00
Tax advantages, leverage and appreciation in
value, could raise the actual return on investment to considerably more than
10% and may influence how much a sophisticated investor might be willing to
pay for a property. Location, condition and improving or declining market
are also factors |
