![]() ![]() On paper, the numbers may look identical. Except one of these properties is brand new, and the other was built 30 years ago. NOI also doesn’t include capital expenditures, such as replacing the roof or major mechanical systems.Ĭonsider two properties, each selling for the same amount, each renting for the same amount, and each with the same NOI. When you include financing costs and calculate your cash-on-cash returns, you discover that Property A with the 7.60% cap rate offers you a 10% cash-on-cash return, while Property B only offers a 9% cash-on-cash return (due to the more expensive financing). You find another lender willing to finance it, but they charge a higher interest rate. Suppose your primary lender doesn’t like Property B with an 8% cap rate and refuses to lend against it. In the real world, investments are never truly equal. Property B is a different building with a cap rate of 8.00%.Īll else being equal, the 8% cap rate would make a better investment, right? Property A is the example above with a cap rate of 7.60%. Imagine two identical buildings – Property A and Property B. Which makes the net operating income $7,596 ($14,400 – $6,804 = $7,596).īecause NOI doesn’t include debt costs, it often doesn’t take the whole financial picture into account. In the example above, we are assuming 8% of monthly rents, plus a one-month new tenant placement fee every two years (which comes to around 4% of annual rents).Īll told, the annual net operating expenses total $6,804 (around 47% of gross rents). With property management fees, remember to include both rent collection percentages and an estimate of new tenant placement fees. It helps clarify the current figures and how expenses will rise alongside rents. Tip: Investors should run expense numbers in both dollar amounts and percentages of the rent. ![]() Utilities included: $0 (you opt to require the tenant to pay directly).Property management fees: 12% ($1,728 per year).Maintenance and repairs: $2,000 (~14% of rents).After analyzing the local market, you come up with the following figures: Then you start doing your homework to estimate expenses. It rents for $1,200 per month, for an annual gross income of $14,400. But before making an offer, you run the numbers carefully. Suppose you find a rental property for $100,000, that you believe will generate a strong cash on cash return. The last place you want to find yourself is stuck with an investment property that costs you money each year, rather than earns it for you. It’s prudent for most investors to err on the side of caution by overestimating expenses. Investors can’t know the exact vacancy rate a given property will see next year, but by analyzing comparable properties, they can arrive at a reasonably accurate long-term average.Įven the concrete numbers like insurance premiums and property tax bills are subject to change. But others, such as vacancy rate, require an estimate. Some of the expenses above are essentially fixed costs, such as property taxes. It also ignores income tax implications (although it does include property taxes). NOI does not include financing costs such as interest. Any other operating expenses, such as janitorial or groundskeeping costs.Operating expenses include all of the following: While gross revenue refers to the total annual rents and other property-related income, operating expenses are a slightly more difficult figure to calculate. Gross Annual Revenue – Total Operating Expenses = Net Operating Income The formula for calculating net operating income is simple enough:
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