The most important metric in valuing a CRE property is the net operating income (NOI). It is used as the basis for CRE valuation whether it is an acquisition, sale, or appraisal. A property's NOI is calculated as follows:
Gross Potential Rent (annual rent for all signed leases plus vacant space at the market rent) |
Plus: Other income (tenant reimbursements, parking, percentage rent, etc.) |
Less: Vacancy (as a percent of the gross potential rent) |
Equals: Effective Gross Income |
Less: Operating Expenses (excluding tenant improvements, leasing commissions, capital improvements and debt payments) |
Equals: Net Operating Income |
The NOI is important because it is the cash flow metric used to value a property. For example, if the NOI in an acquisition is $1,000,000 and the purchase price is $15,000,000, then the cap rate is 6.67% ($1M/$15M). NOI is also important because it represents the initial cash flow from the property in which tenant improvements, leasing commissions, capital improvements and debt service (annual principal and interest on the debt) are paid. Many lenders also use NOI to value a property for loan purposes and a loan yield. The loan yield is the lender's NOI divided by the loan amount. Most lenders seek a loan yield of at least 9.0%. Therefore, calculating and using the appropriate NOI is critical to making smart acquisition decisions. After all, most of the profit made on a CRE deal is when the property is bought, not when it's sold.
Want to continue reading?
Become a Free ALM Digital Reader.
Once you are an ALM Digital Member, you’ll receive:
- Breaking commercial real estate news and analysis, on-site and via our newsletters and custom alerts
- Educational webcasts, white papers, and ebooks from industry thought leaders
- Critical coverage of the property casualty insurance and financial advisory markets on our other ALM sites, PropertyCasualty360 and ThinkAdvisor
Already have an account? Sign In Now
*May exclude premium content© 2024 ALM Global, LLC, All Rights Reserved. Request academic re-use from www.copyright.com. All other uses, submit a request to [email protected]. For more information visit Asset & Logo Licensing.