Net Operating Income: Cutting Out The Noise
By Wade
Ogletree
When it comes to income-producing real estate, buyers are faced with
a lot of NOISE—Net Operating Income Significantly Exaggerated. So, how
do you tell the real NOI from the noise? Be realistic about the gross
operating income and know which operating expenses are standard—the
expenses your lender will expect to see.
The industry standard for operating expenses in residential rental
properties includes: real estate taxes, property insurance, repairs and
maintenance, utilities, management, janitorial, and interior/exterior
decorating. Is that what the seller, the seller's agent, or even your
agent is giving you? Probably not.
The first numbers an investor sees on a property are the pro forma
data. A dictionary definition of pro forma designates it as an
adjective, meaning 1) "Done as a formality; perfunctory" or 2)
"Provided in advance so as to prescribe form or describe items: a
pro forma copy of a document." (Dictionary.com)
For our purposes, it is most helpful to return to the Latin roots of
the word. Pro forma, translated from the Latin, basically means
"for the sake of". The pro forma data presents information
based on assumptions that do not currently exist but "for the sake
of" argument, the data assumes are true. The pro forma may present
income potential under the assumptions that 1) occupancy is 100%, 2)
rental rates have been raised, and 3) expenses have been cut. Meanwhile,
the real numbers state that at the lower, current rental rates, and
higher expenses, occupancy is significantly below 100%.
Be realistic about the gross operating income. Think like a lender.
As an investor, you see the potential for raising rental rates. A lender
cannot see potential. A lender can only see what is and, as such, will
require three years of income and expense statements.
The good news here, in dealing with your lender, is that the standard
operating expenses can now help save your loan. In the pro forma,
certain standard expenses may have been overlooked, but if your lender
gets her hands on the seller's tax documents, expenses are going to jump
off the page like lemmings, one after the other, in a suicidal attempt
to destroy all traces of income. When you learn to think like a lender,
you will see past claims that fall beyond the scope of normal operating
expenses. You will see the real income and the standard expenses and
will emerge, up out from the noise, with the true net operating income.
Note: Author Wade Ogletree is also the creator of this site, Southern
Investor.
You're due for a touch of Southern Profitability. Southern
Investor is your real estate investment resource, presented by Wade
Ogletree, Century 21, Professional Services.