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Net Operating Income

Posted by capital on May 4, 2018
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The real estate industry considers Net Operating Income (NOI) a key metric in determining property valuation. At the same time, the industry lacks standardization of the definition. It’s critical to understand what is included, why, and how it is being included.

The determination of Net Operating Income is Potential Gross Income(PGI) Less Vacancy & Credit Loss plus Other Income Less Operating Expenses.  It’s important to ask if Replacement Reserves are included in the NOI calculation. Some in the real estate industry include Replacement Reserves as part of the calculation and others do not.

Potential Gross Income(PGI) consists of rent multiplied by the total rentable units or rentable square feet. This includes Contract rate multiplied by Leased units plus Market rates multiplied by unleased units. This must be determined on the basis of individual tenant leases and space configurations. In determining PGI, keep in mind Tenant leases will typically differ, contract and market rates and terms may not be equal, and the value of all space configurations may not be equal.

Vacancy & Credit Loss is the loss that all assets incur, at least on a periodic basis from vacancy and non payment of rent. The conventional practice is to include a vacancy and credit loss factor in all pro-formats, even if an asset is one hundred percent leased. This is done because all assets will experience tenant roll-over and most assets experience loss due to tenant default or non payment of rent. Vacancy and credit loss also impacts assumptions made with respect to other line items such as expense reimbursements, variable and leasing costs.

Other Income, also referred to as Ancillary Income consists of the loss that all assets incur, at least on a periodic basis from vacancy and non payment of rent. Examples include Percentage Rent, Service Income, and Parking Revenues.

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