"Which number is the most important?" a new student asked me some time ago.
Without hesitation I answered, "Net Operating Income."
I went on to explain that the Net Operating Income (NOI) was the most important number he'd ever calculate. Sure, the cap rate, Gross Income Multiplier (GIM), the dollars per unit and dollars per foot all matter. But if the NOI is wrong, everything else is wrong too.
"Yeah but the dollars per unit and dollars per foot is still right," he answered.
"That's true. But how much of that do you get to deposit into the bank every month?" I paused for a minute then continued. "Did you know that the number one reason investors overprice their property is because they don't calculate the NOI correctly?" He quickly agreed. "That said, the number one reason buyers overpay for apartment buildings is because they miscalculate the NOI as well."
We kept talking as I opened up a variety of reasons and tips to correctly calculate the NOI.
It's true. The NOI is without a doubt the most important number you'll ever calculate. And the second most important number you'll ever calculate is the "pro forma" or "market" NOI. The bigger the spread, the more money you'll make. I'll explain that in a minute.
As I begin talking about NOI many people say, "This is a no brainer. It's easy. I don't need to read this."
It is easy. Yet everyday I look at property where the income and expenses make zero sense. For those that are just beginning, the NOI is calculated by subtracting vacancy and expenses from the income produced by the property. If it's so simple, why is it wrong most of the time?
Two reasons: Buyers and sellers. I can't even begin to tell you how many sellers I've met with who said to me, "But my expenses aren't that high." Ask any commercial real estate agent if they've ever heard that and you're sure to get a chuckle out of them. Many sellers manage and operate the property on their own. They fix the toilet, move in new residents and paint the units when they turnover. They take the calls at 3:00 a.m. when the water heater bursts or the power goes out. They don't pay someone else to do it. And if they don't, their expenses are, arguably, lower.
Here's a good rule of thumb to try to live by if you want to avoid making serious mistakes when buying and selling apartment buildings:
Know what lenders are doing.
It doesn't matter if you're using a lender or not, know how they're underwriting property. It's very, very easy to look at a building where the seller is offering you the world--maybe they're offering you a property with little or no money down--and it appears that the building is financially attractive. Maybe it is and maybe it isn't. Think about your exit strategy. What would happen if you had to sell the property the next day? Could you get your money back?
To learn more about how to analyze apartment buildings, check out the course When, Where and How to Buy.
Wish you all the success,
Steve Steadele
About Steve:
Steve Steadele, author of the book Multifamily Millionaire, is a successful Real Estate Investor, Broker, Entrepreneur and self-made millionaire. He is a featured speaker at Real Estate Investment Associations across the country where he shares his wealth of knowledge, experience and enthusiasm for the real estate industry. Today Steve specializes in the acquisition and disposition of investment real estate throughout the United States. To learn more about his products and services, visit his Web site at www.SteveSteadele.com.
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