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ALL ABOUT REAL ESTATE INVESTMENT STRATEGIES
Misleading Operating Statements In the acquisition of an income producing property an investor can safely assume that the seller's initial price expectations exceed the property's economic performance. An informed investor will make every effort to establish a reliable Net Operating Income (NOI) that will support a realistic purchase price. Net Operating Income is a key factor in determining value. NOI is that sum remaining after deducting vacancy allowance and operating expenses from gross income. The Ideal form for detailing income and expenses is the Annual Property Operating Data (APOD) form developed by The Commercial Investment Real Estate Institute, it is highly recommended as an accurate method of examining income and expenses. Since the Net Operating Income (NOI) plays a key role in determining value, there are usually two sets of income and expense figures at the outset of investment real estate transactions...as outlined below. Continued below
The first set of income and expense figures are prepared by the seller and often reflect exaggerated income and understated expenses arriving at an NOI that supports an inflated asking price. Seldom if ever in a sellers income and expense statement is a vacancy allowance considered. Routinely, repairs and maintenance and property management expenses are excluded because the seller personally handles property management as well as repairs and maintenance. Often last year's real estate taxes or fuel bills are indicated. It should be expected that a sellers income and expense statement will offer a higher NOI in order to command a higher sale price. The second set of income and expense figures should be a reconstructed statement, that of a prudent purchaser utilizing the APOD form to arrive at a credible net operating income that will support a reasonable purchase price. Income should be confirmed by reviewing existing leases with an eye toward maximizing rental amounts. A minimum vacancy factor of five percent can be included, a management expense of at least five percent should be factored in whether or not the purchaser intends to manage the property personally. Depending on the age and condition of the building and the tenant responsibilities specified in the leases, a repairs and maintenance expense ranging from four percent to eight percent might be considered. Real estate taxes as well as general operating expenses should be anticipated to increase at least two percent over current figures. Following these guidelines in preparing a reconstructed income and expense statement can contribute to the development of a dependable Net Operating Income (NOI). It is important to understand that net operating income is the underpinning for every reliable method of evaluating an income producing property. Whether it be a capitalization method of establishing value (cap rates), determining cash on cash return, internal rate of return or investment value, net operating income is the very foundation in establishing value. About the
author: Stewart L. Mac Donald, CCIM, is President of
Real Estate Assets, Inc., a consulting services company
focused on maximizing wealth through Asset Management in
the real estate portfolio. Mr. Mac Donald has counseled on and
has been an active participant in a wide range of investment
real estate projects. He has written and presented seminars on
"Strategic Planning in the Investment Real Estate
Portfolio" before bar associations, financial planning and
investment groups.
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