The net income and property produces annually is the singularly most important piece of the lending puzzle. NOI coupled with Debt Coverage Requirements determine maximum loan amounts. In its most simplified form, lower NOI equals lower loan amount. So what is NOI and how is it calculated?
NOI is simply the income left at the end of the year after all the revenue has been collected and all the expenses taken out. The key, however, is determining the correct income and the correct expenses. As we see frequently, listing packages on properties for sale (as an example) are notorious for overstating the income and understating the expenses. Often when looking at listing packages, you will see the term ‘Pro Forma’ income. That’s code for, not income that’s been achieved yet. In calculating your actual net income, you need to know the collected income currently – not based on a projection. Most of the time, the difference between the projection and current rents is small and doesn’t have a major impact – but it does have some impact. Another area to always consider on a purchase is vacancy estimate. While less than 5% might be normal for the market, lenders always use 5%. The other item to consider is additional income. However, that part will be discussed in a separate short paper.
The expense side is usually the more difficult to interpret. In the case of listing fliers, you simply need to be aware of normal market expenses as opposed to what may be in the listing. For example, we often see maintenance and turnover expenses listed at very low estimates. While that may be true for the current owner, the normal market expenses (which is what the appraiser and lender will use!) will be higher. As a property owner, it’s a good rule to assume expenses will be higher as a hedge against over estimating the bottom line net income. Once you dive deep into the historical expenses which are provided in a purchase transaction, you can parse through what seems overblown and what is under done. This is in part where a good mortgage broker as an outside pair of eyes can help – particularly based on their knowledge of the market.
Once you have a good understanding of both the expected net collected income and the anticipated expenses, you can finally calculate the net operating income. Once you have the figure, you with your broker can begin playing with different loan programs, rates and structures to determine the best fit on the financing side relative to your own strategy and the net income you can reliably anticipate.
To that end, if you are interested in having a projection template which calculates all of these various pieces to arrive at a net operating income and then based on loan parameters the debt coverage, please feel free to reach out at info@commercial-lender ,com. We’ll be happy to email you our generic spreadsheet which can help visualize all the variables and help you see the bottom line.
