Dc Fawcett guidelines
When you invest in real estate properties, you need to know the method for calculating the property value when you are buying them. You can calculate the capitalization rate only when you use the property’s net operating income and recently sold prices. DC Fawcett gives you the guidelines about the net operating income in real estate.
Net operating income in real estate
It is a calculation that is used to analyze real estate investments which generate income. It is the result of the property revenue minus all the expenses incurred. In other words, it is gross operating income minus operating expenses. Apart from rent, you can also get income from parking and laundry machines. Operating expenses are the expenses that are needed to run and maintain the building or the property on its grounds. Insurance, property management fees, utilities, property taxes, repairs, and janitorial fees are these expenses. NOI is the operating income before tax. Principal, interest payment on loans, capital expenditure, depreciation, and amortization are not included in it.
Formula for NOI is as follows in case of rental income is
Net operating income is positive when gross operating income is more than operating expenses. It is negative the other way round. NOI can either be on the basis of historical financial statement data or projected financial statement data for the future.
It measures the capacity of the property to generate income from the income stream operation. The difference between cash flow before tax and net operating income is that former is calculated on a typical real estate proforma and the latter excludes any financing or tax costs that the owner incurs. In other words, it is unique to the property more than the investor.
How to calculate net operating income
Net operating income calculation is simple once you get the break-up amount of individual components. The components are
- Potential Rental income – Is the sum of all rents under the terms of each lease with an assumption that your property has been rented out and it is occupied. If it isn’t fully occupied, then a market-based rent is taken to consideration on lease rates and the terms of comparable properties.
- Vacancy and credit losses – It is the income lost from the tenants who have either vacated the property or have defaulted by non-payment of rent or lease. For the purpose to calculate NOI, the vacancy factor is calculated on the basis of current lease expirations as well as the market is driven figures with the help of comparable property vacancies.
- Effective rental income – The outcome of this is the result of potential rental income minus vacancy and credit losses. This is the income that the owner can expect to collect which is reasonable.
- Other income – This is the income the owner gets other than the rental income. They can get the income through billboard/signage, parking, laundry, vending etc.
- Gross operating income – it is the result of effective rental income plus other income that is generated from the property.
- Operating expenses – It includes all the expenses like property taxes, insurance, management fees, repairs and maintenance, utilities, and other expenses.
- Net operating income – It is the result of deducting operating expenses from gross operating income.
DC Fawcett concludes that Net operating income is as good as the net profit earned out of rental income or the property sale.