Commercial Loans and NOI

When dealing with commercial loans and commercial real estate, it is crucial to know and understand a number of terms. We have put together a full glossary of commercial loan terms for you, with all of the following terms defined, among others:

• Deferred maintenance account
• Absorption rate
• FMV
• Stabilized NOI
• EGR
• Estoppel certificates
• APR
• Debt Service

Today, however, we are going to explore one of the most crucial terms to help in evaluating a commercial property, NOI. Net operating income, or NOI, is perhaps the single most basic and important concept to understand, as many calculations relating to the financial strength of a commercial property are tied to this concept.

There are two basic ways to evaluate the income on a commercial property. These are contract rent and market rent. Market rent is basically what you could rent your space for on the open market. This can be found by doing a market survey. Contract rent, on the other hand, is what the space is actually being rented for now

When compiling your numbers, use the market rent number for your vacant space in the commercial property. For all space that is currently rented out, you will use the actual or contract rent. When putting these numbers together, you may note that if your contract rent is less than market, your commercial property valuation could suffer.

When making commercial loans, the basic value system used is the income approach, which requires the NOI to be calculated. In order to calculate this, once you have your income numbers, you will then need to find the total operating expenses. Operating expenses are exactly what they sound like, all of the expenses and allowances associated with your commercial property. Debt service is not included in this .

When figuring the operating expenses, you will have two types of expenses. These are fixed expenses and variable expenses.

Fixed expenses are expenses that stay the same no matter how high your vacancy might be. Real estate taxes are a good example of fixed expenses. Variable expenses are those expenses that do vary depending on the vacancy factor. A good example of a variable expense is utilities. In addition, often times you will include a replacement reserve in these operating expenses.

Once your operating expenses are gathered, you need to find your effective gross income. This is the income from the property after taking into account a vacancy factor. Subtract your operating expenses from your effective gross income and that will be the net operating income of the property. When dealing with commercial loans or commercial real estate, the net operating income is important to know, as it can really tell you a lot about the health of a property.

You can use the NOI of a property to look at a number of aspects related to the property. When lenders make Commercial loans, value is loosely based on the net operating income. You can use a combination of cap rate and the NOI to find an implied value for a commercial property. If your net operating income is 80,000 and the cap rate for your area is 7%, your implied value for the subject property would be just over $1.1m.

Commercial lenders will also look at the pretax cash flow of a property, the debt coverage ratio of a property and the annual debt service of a property. All of these rely on the net operating income number, making net operating income a very important number to be comfortable calculating.