How do you communicate NOI to potential buyers, lenders, and appraisers in commercial real estate?

A household analogy I would use is to start with your paycheck - Subtract utilities - Required maintenance - Lawn, pool, Wi-Fi, etc That is your NOI Revenue less operational expenses = NOI What is leftover to pay your mortgage? In commercial real estate, many floating rate, loans are facing this dilemma of NOI insufficient to cover the mortgage.

Unfortunately you have left out vacancy and credit loss that must be subtracted from Potential Gross Income BEFORE subtracting operating expenses. Vacancy and Credit Loss is often overlooked and can significantly affect NOI.

More importantly to potential buyers is Cash Flow Before Taxes CFBT. This is the revenue realized after debt service is deducted from NOI, before government taxation. Requires determining annual mortgage/financing costs and delivers a more realistic representation of what an investors true ROI is. Also allows for determining a true discount rate on an buyers investment (Cash on Cash) the return the downpayment realizes and evaluating the investment value.

Steve, isn’t CFBT a dynamic figured unique to each buyer & dependent on the financing terms they are able to negotiate &/or qualify for? CDBT will be dramatically different when comparing a buyer who is highly leveraged with debt.

The DSCR required by a lender varies and is determined by a number of factors. Those include whether a property is stabilized or in transition to stabilization, what use the property serves (retail vs office vs apartment etc), the property’s immediate past operating history (how well or poorly it has recently performed financially), and the degree of risk a lender is willing to take on their investment. For example, an apartment that has below-market average rents “in-place” at funding but could be lifted to market through an upcoming rehabilitation program might qualify for below a 1.2x in-place DSCR, whereas a fully-rented property at market rents would likely need to show a DSCR at 1.2x or above.

One of the most common ways to lower operating expense burden to the owner, thereby raising the NOI, is to restructure leases to pass some or all operating costs to tenants. Changing the terms of a lease from Gross, where all operating expenses are covered by the owner, to Net, where some or all are covered by the tenant, is a popular strategy if it is typical within the property’s market and at comparable properties. This strategy requires very exacting accounting standards and reporting of operating costs to the affected tenants, which can add to the administrative burden of property management.

You ask 100 people to estimate an NOI on a property and you'll probably get 100 answers. When we evaluate properties to solicit loans we follow a thorough underwriting process with detailed notes on each line item (income & expense). The lender(s) may not agree with our underwriting but we've at least given the logic behind our conclusions and any math that was involved. That generally leads to better and more clear discussions about the loan proceeds they may be able to provide.

Let me tell you about a time I learned an important lesson communicating NOI. I was representing a seller of a small retail plaza. We got an offer contingent on verifying NOI. I sent my calculations, but the buyer had questions. Caught off guard, I got defensive insisting my NOI was right. Realizing my mistake not explaining my methodology, I did a reset walking through each item. We talked through different assumptions and arrived at an agreed NOI. The lesson: present NOI numbers with context, explain methodology, address questions. Clear communication keeps deals on track.