With a good understanding of NOI, you can confidently invest in apartment or multifamily properties with a good return on investment. Knowing your NOI is crucial to successful apartment investing and will help you make informed decisions about the properties you invest in. We discussed multifamily real estate lingo in a previous episode and blog on our website, along with various terminology. You might be pondering why is this essential. With this knowledge, investors can make decisions that are in their best interest and ensure that they get what they need.
What is NOI?
Simply stated – The Net Operating Income (NOI) includes all revenue from the property, minus operating expenses. NOI does not include capital expenditures and mortgage payments. NOI is an important metric used when evaluating various investment properties. It provides an insight into the potential return on a particular property and is a key factor when evaluating the profitability of a potential real estate investment. NOI measures the net income that is generated by the property after considering all of the operating costs affiliated with it like taxes, insurance, and maintenance.
By understanding NOI and calculating it properly before investing in a property, investors can make better informed decisions and ensure that their investment will be profitable. NOI is calculated by calculating the total income from the property and subtracting any operating expenses. It is also important to note that NOI does not include debt service or other financing costs, meaning that it gives a true reflection of the profitability of the investment. Knowing NOI can help investors be certain they are making smart investments that will provide a positive return on their investment. By understanding and properly calculating NOI, investors can make more informed decisions when investing in real estate and ensure a successful venture.NOI is the number that tells you how much income your property will yield, minus any operating expenses. It’s the amount of money left over after all of the expenses associated with your apartment or multifamily property have been paid. With a good NOI in hand, you can also determine if an investment property is worth pursuing.
Once you know your NOI, you can use it to determine the value of your apartment or multifamily property. This is done by calculating the NOI, and then dividing it by a capitalization rate (or cap rate). The cap rate is the rate of return you expect to get on your investment. By multiplying your NOI by the cap rate, you can determine the value of the property. For example, presuming the cap rate is 5% on a property, calculate the valuation of the property by dividing the NOI of $150,000 by the 5% (or .05) cap rate. And the valuation of the property equates to $3,000,000. You might be wondering why is the formula relevant for you…In contrast with single family residences where the value is determined from a comparable property’s sold price, the value of commercial real estate is based on the income it produces. So that is the reason why NOI is so important; minimal modifications in it can significantly affect the property’s value.
Understanding NOI and how to calculate it is essential for successful apartment investing. The quick math formula to calculate NOI (and the profitability of an investment) is to subtract operating expenses from the effective gross income. For example, if your effective gross income is $300,000 and your operating expenses is $150,000, your NOI is $150,000.
So hypothetically from the previous example, we deduced expenses by $30,000 and boosted income by $60,000. The new NOI would be $180,000. Now, calculate the new NOI by dividing it by the 5% cap rate. The property’s valuation WAS $3,000,000. Yet, now the NEW valuation is $3,600,000. That’s a phenomenal $600,000 boost from the initial value!
So now you might be pondering – what are some variables that can help boost NOI? Well, that would include increasing effective gross income and/or reducing operating expenses. Yet, the syndicator would have to conduct due diligence on the market and what competing apartments in the area are offering, in terms of amenities, etc.
To view the list of strategies to increase income, click here.
Another method to boost NOI is to optimize and streamline expenses. Best practice is that operating expenses should be close to 50% or less of the effective gross income, or operating expense ratio. That doesn’t necessarily mean that you pass on deals with higher operating expense ratios. Why? It could be that you can deduce expenses by optimizing and having top-notch operators oversee the investment. The easiest way to initially deduce expenses is to not overpay for services at the property (i.e. maintenance and landscaping).
To view the list of strategies to reduce expenses, click here.
Note, in summary, you have to determine, which strategies are suitable for you and your investment…That’s why it is important to know, like, and trust your deal sponsors and/or operators. If you are unaware of all the nuances or lack the time to devote to learning and monitoring syndications, a competent, syndicator can do all of the work; and that’s why passive investing is a great solution for busy professionals! When it comes to multifamily investing, the key metric we look at is Net Operating Income (NOI). Generally, the higher the NOI, the greater return on investment we can expect from a multifamily property. This is why we always focus on finding multifamily apartment properties with high NOI or ones that have the potential to generate high NOI. By investing in these types of properties, we can successfully scale, flourish, and in time, sell the property for 2-3 multiples. With this in mind, it is essential to understand how to calculate NOI and how it can affect your return on investment when purchasing a multifamily apartment property. If you execute the proper business plan, your NOI will rise!
To learn more about this topic, click here.
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By Kelsie Mans-Ray
KMR Multifamily Acquisitions / Syndicator
NOTE: This information is of a general, educational nature and may not be construed as tax, financial, or legal advice pertaining to a specific offering, exemption or situation.
