Analyzing Beyond NOI - Three Things To Consider Part 2

There are a number of ways to look at return on investment using a Net Operating Income calculation. When analyzing a piece of real estate, most people start off with NOI. They make all their assumptions based on cash coming in and the operating expenses. Most people use the traditional method of calculating NOI by simply taking gross income and deducting all the operating expenses to arrive at a figure. You must analyze beyond NOI because some expenses are not included. Expenses not included are debt service (mortgage payments—principle and interest) income tax, replacement reserves, depreciation, and charitable donations. Another approach to analyzing NOI is to use Potential Rental Income (PRI). That’s the gross amount of money you’d have if all units of the property were rented 100% of the time.  Although this breakdown uses a slightly different formula, it is actually the same as the basic NOI formula, only expressed differently. As you know in business, there are many different scenarios you can encounter. You can hope for the best-case scenario, but always plan for the worst case. For instance, you deduct the loss resulting from vacant units and credit losses you may have to take if your tenant stays in the property without paying rent. To compare one property or deal with another, you start by listing some basic figures. NOI using PRI  (Potential Rental Income) Analysis When someone says this property’s NOI is $95,000, they mean that they’re projecting that it will be $95,000 for the first year you own it. What you hope is that the first year’s NOI is a measure of the worth of a building when you look at it against other things. This is another reason to analyze beyond NOI. To estimate your NOI accurately, you must analyze your leases and the marketplace. Most Pro Formas will give you items like potential rental income and estimated vacancy. However, you must determine if other elements should also be factored into your operating expenses, such as: • Below and above market rents • Management fees • Debt service • Reserves for replacement • Cost recovery, charitable donations, and income taxes Therefore, when you analyze beyond NOI and consider all expenses, you can make better decisions on if a deal will be profitable.

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