In my previous blog post I promised to explain some of the basic calculations necessary for investing in commercial real estate. I'll start today with what I believe is the beginning, Net Operating Income (NOI). I will present a simplified version of this calculation today, and will get into more details in a future post. So, let's assume we are thinking about purchasing a small retail property in reading, PA. One of the first things that we ask the seller for is his financials or P&L's. Often when we ask for this, we get some numbers scratched on a piece of paper, or a bunch of bank statements. How do we make sense of this information?
We start by determining the determining the Effective Gross Income (EGI). So you take the rent roll that the owner of this small retail property has given you, and determine that the base rent is $2,000/month or $24,000/year. You also notice that in addition to the base rent, the tenant is required to reimburse the landlord for 100% of the property taxes (This makes it a single net lease, but we'll discuss that at a later date). Finally, the landlord has a license with a vending company that provides an additional $50/month. Add up all of those numbers, and you get the Gross Income. Then you have to subtract any vacancy or collection loss, and you get the Effective Gross Income. So the income portion of your statement looks like this:
To calculate the expenses, you can usually start with the owners check register, or invoices. You should get your own quotes whenever possible to verify these numbers, and if you are projecting, it is often advisable to inflate these numbers by 2-5%. Add up all of the expenses as seen below:
Next you simply take the EGI, and subtract total expenses, and you get NOI:
Please remember that today I'm only talking about the calculation itself. Getting the numbers to enter into your calculation is where the 'art' portion of evaluating commercial real estate investments comes into play. So now that we have an NOI, should you invest in that small retail property in downtown Reading, PA? The answer of course is that we don't yet have all the information necessary to make an informed decision. I'll save that for future blog posts.
If you are interested in investing in commercial real estate, and you'd like assistance evaluating the numbers, give me a call today.
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