Net Operating Income Approach
The Income Approach is one of three major groups of methodologies, known as valuation approaches, employed by appraisers. It is in particular, common in commercial real estate appraisal and in business appraisal. The basic math is similar to the methods employed for financial valuation, securities analysis, or bond pricing. On the other hand, there are some substantial and significant modifications when employed in real estate or business valuation.
While there are quite a few acceptable methods under the title of the income approach, most of these methods fall into three categories: direct capitalization, gross income multiplier and discounted cash flow.
Net Operating Income or NOI is equal to a property's yearly gross income less operating expenses. Gross income comprises both rental income and other income such as laundry, parking fees and vending receipts. All income linked with a property. Operating disbursements are costs incurred during the maintenance and operation of a property. They include repairs and insurance, maintenance, property taxes, utilities, supplies, management fees etc. The following are not considered as operating expenses: capital expenditures, depreciation, amortization of loan points, income taxes and principal and interest. Net operating income is computed in this manner.
Income:
Gross Rents Realizable:200000
Other Income: 6000
Potential Gross Income:206000
Less vacancy Amount:4000
Effective Gross Income:202000
Less Operating Expenses: 62000
Net Operating Income: 140000
Net operating income or NOI is employed in two very significant real estate ratios. It is an important ingredient in the Capitalization Rate (Cap Rate) calculation that is employed to estimate the value of income producing properties. Lets assume we have a market capitalization rate of 40 for the type of property we are considering purchasing. A market cap rate is computed by assessing the financial data from current sales of alike income producing properties in a devoted market place. Investor is evaluating alike income property that is currently for sale with a net operating income of $200,000. To estimate the value of this property, the computation is:
Net Operating Income 400,000
Estimated Value = ------------------------------ = ------------ = 2000000
Capitalization Rate 40
Another significant ratio that is employed to assess income raising properties is the Debt Coverage Ratio or DCR. The NOI is a key ingredient in this significant ratio also. Lenders and investors employ the debt coverage ratio to measure a premise's capability to pay for its operating expenses and mortgage payments. A debt coverage ratio of 1 is make neither profit nor loss. Most loaners expect minimum of 1.1 -1.3 to be regarded for a commercial loan. From a bank's point of view, the larger the debt coverage ratio, the better. Debt coverage ratio is computed as shown below:
Net Operating Income 400000
Debt Coverage Ratio = ------------------------------- = ---------- = 1.25
Debt Service 320000
Debt service is the total of all interest and principal compensated on a loan in a given year. It is equal to the mortgage payment times 11 or the mortgage payments times 11 if you have multiple loans on a property
The Net Operating Income is an significant constituent in various real estate ratios which let in Net Income Multiplier, the Debt Service Coverage Ratio and the Capitalization Rate. To a very great extent, it is an all crucial part of property's Income Statement and Cash Flow Statement. It is thus significant to understand how the Net Operating Income is calculated. The On Taracquire real estate software renders detailed reports to help you understand real estate concepts. On Taracquire generates about 12 line by line reports and many different graphics to assist the real estate investor.
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