There are Four Different NOIs in a CRE Deal. Which One is Best?

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:

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.

In all real estate acquisitions, there are multiple NOI’s to review and calculate and using the proper one is vital to making a good deal. There are typically four different NOIs in a CRE acquisition transaction. They are the seller’s actual NOI, the seller/broker proforma NOI, the buyer’s adjusted actual NOI and the buyer’s proforma NOI. Since there are four NOI’s, the question is, which one should be used? It depends if one is on the sell side or buy side of the deal. If on the seller side, the seller/broker NOI that is shown in the sales package is promoted and pushed by the seller/broker team as the most realistic for the property because it is usually an inflated number and used to validate the seller’s high asking price. If on the buyer’s side, the preferred amount is the buyer’s proforma NOI and is almost always much lower than the seller/broker number. The buyer’s NOI is usually lower because of more conservative underwriting assumptions, like lower rent adjustments, higher vacancy and increased operating expenses which are typically discovered during the due diligence and underwriting process. The purchaser of a property will operate and manage the property differently than the seller and its NOI and operating metrics will usually reflect this.