Net Operating Income (NOI) & How To Calculate It

Real estate investors need information. The more information they have, the better the decisions they can make. There are a lot of tools to provide this information, but one of the most important is net operating income (NOI). Understanding what this calculation is and how to use it can help investors make decisions quickly regarding any property an investor is considering.

What Is Net Operating Income?

The NOI formula allows a real estate investor to determine how profitable a property could be. The formula is straightforward. Subtract all of the operating expenses for the property from the expected revenue it should generate. Expected income may include rental income but also any additional fees or income associated with the use of the space. Operating expenses may include any type of general expenses for the property, such as insurance costs, taxes, and repairs.

With this information, an investor can see if the cost of operating the property is more than the potential earnings from it, making it easy to determine if that investment is appropriate for their goals and financial needs. Often conducted prior to purchase, it may help in making buying decisions between multiple properties. For example, if there is a consideration for purchasing a convenience mart, this calculation would take into consideration all potential avenues of income from that convenience mart. That may include tenant rent as well as any income from the sale of goods. It would also consider all maintenance fees for the property and any other associated costs, such as the attorney the investor uses or the insurance on the property. This is what makes net operating income so valuable. It takes into consideration all of the income and expenditure opportunities for the property in one single calculation. As a result, the investor knows right away if this is the type of investment that fits the investor’s portfolio or not. NOI is calculated before tax. It is often presented on a property’s income and cash flow statement. Typically, it does not include principal and interest payments on loans, depreciation, capital expenditures, or amortization.

Why Is Net Operating Income Important?

The key to using NOI is to understand its value. When an investor uses this calculation, it will help provide insight as to the property owner if renting out the property is worth the expense of purchasing it as well as maintaining it over time.

Often, this information can help prospective investors determine which property available to them may offer the highest return or fit within their property investment strategy best. It allows the investor to compare several properties with the same metrics, making it easier to see the difference in each.

How to Calculate Net Operating Income

To calculate this information, it is necessary to have all data available (as much as possible). The simplest explanation is to subtract all of the operating expenses required for the property from the revenue the property could generate. Revenue may include:

• Rental income
• Service charges
• Vending machines
• Parking fees
• Other sources

The operating expenses could include:

• Property management fees
• Insurance costs
• Maintenance and upkeep costs
• Utility costs
• Property taxes
• Repairs

Net operating income formula:

Net operating income = RR – OE

RR: Real estate revenue OE: Operating expenses

Example of How NOI Works: Net Operating Income Formula Example

The NOI can be applied to many types of commercial real estate. In every situation, though, the prospective investor needs to consider all avenues for generating an income for that space.

Consider the use of a townhome. A prospective investor wants to learn how much of a potential profit they could generate from the rental of the townhome. The property features 4 townhomes under the same roof and would be leased to resident tenants. Here is a basic overview of what could occur.

Calculate the revenue

The first step is to add up all the revenue that comes from owning this townhome and renting it out on a yearly basis.

• The total rent collected ($1000 per month per unit equals $4000 per month, for a gross $48,000 in rental income for the 4 properties)
• Garage rental costs ($50 per month per unit, equaling $200 per month, or $2400 per year)
• Laundry machine use ($25 per month, per unit, equaling $100 per month, or $1200 per year.)

In this situation, the total income from the property could be $51,600.

Calculate the expenses

The next step is to determine the total cost of operating the townhome property. Some of the costs could include:

• Property management fees: $5000 a year
• Property taxes: $10,000 a year
• Maintenance on the property: $10,000 a year
• Expected repair costs: $15,000 a year
• Insurance: $8,000 per year

In this situation, the total operating expenses for the property are $34,500. To determine NOI, use the formula for NOI: $51,600 minus $34,500 equaling: $17,100 That means that the property would yield $17,100 in profit each year, assuming these figures hold up.

Evaluating the Potential of a Property

Not every situation produces a positive result. Suppose a property’s NOI shows a negative result. In that case, that could indicate the property would not be profitable to manage, especially if the costs cannot be lowered in any other way. Some potential investors may think of the long-term outlook after they’ve made repairs or updated the property to lease it at a higher rate. However, if that does not happen, the NOI may not be positive.

Borrowing to Buy Commercial Real Estate Relies on NOI Information

While NOI is a very important determinant of the value of any property for investors, it is also an essential factor for lenders. Most creditors and commercial lenders will rely on this information to determine the potential income generation for the property. Suppose the investors hope to secure a loan on the property. In that case, the lender needs to ensure that the income generation potential here meets the financial obligation the borrower is taking on.

It allows commercial lenders to assess the initial value of that property by getting a better idea – or for casting – cash flows for it. If the property presents a positive, profitable NOI, that indicates to the lenders there may be some stability in this loan, and they may be willing to make it. If the property shows a negative NOI, that may mean the lender will reject the loan request because of the high risk for the property. In some situations, property buyers may manipulate this information. For example, they may be able to defer some types of expenses while accelerating costs. This may include altering the rents and other fees they plan to charge to present a more positive outlook for the lender. However, it is critical to consider the accuracy here since this could play a role in just how profitable any investment could be over the long term. What is a good NOI? That depends on the specific situation. NOI is not a percentage but rather a dollar amount. Investors need to take into consideration what level is appropriate for their unique needs. The higher the NOI is, the more profit potential it has. The use of NOI is very important in nearly all commercial real estate investments. It does not take long to calculate once all of the information on operating expenses and potential income is available. It is essential for investors to be as accurate as possible.

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Source: Net Operating Income (NOI) & How To Calculate It

https://www.creconsult.net/market-trends/net-operating-income-noi-how-to-calculate-it/

Apartment Vacancy Has Ticked Up for Seven Consecutive Months

 

Vacancy rates won’t hit 6 percent until well into next year.

Vacancy levels bottomed in October 2021, and since then, the situation has eased gradually but the market remains historically tight.

Apartment List’s data show vacancy ticked up for seven consecutive months, reaching 5 percent in May. Its rent growth index shows a corresponding trend, as price growth has decelerated this year compared to 2021.

The rental listing site said it’s possible that the easing of vacancies could level off in the coming months due to rapidly rising rents that may incentivize many renters to stay put and renew existing leases rather than look for new ones.

“At the same time, the recent spike in mortgage rates has created yet another barrier to a historically difficult for-sale market, potentially sidelining would-be homebuyers and keeping them in the rental market,” the company said in a release.

Demand Leveling in Hottest Apt Markets

Markets that saw large spikes in vacancies in the early pandemic such as San Francisco, Boston, Seattle, and Washington, D.C., have since seen renters return.

Meanwhile, demand is leveling off in the nation’s hottest markets.

Seattle, Boston, and DC (as well as many other similar cities across the country that were greatly impacted by the pandemic) are seeing their rents back above pre-pandemic levels.

San Francisco is a rarity in that it still is experiencing a pandemic “discount,” but even there, rents are up 20 percent since January 2021.

Availability of vacant units nationally remains notably constrained compared to the pre-pandemic norm. “Even if vacancies continue their gradual easing, it won’t surpass 6 percent until well into next year on its current trajectory, the firm estimated.

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Source: Apartment Vacancy Has Ticked Up for Seven Consecutive Months

https://www.creconsult.net/market-trends/apartment-vacancy-has-ticked-up-for-seven-consecutive-months/

Tech Companies Cast Their Eyes on Apartment Portfolios

 

Two recent acquisitions have third-party managers’ and industry analysts’ attention.

When it comes to property management companies and technology supplier partners, the script has flipped for some this year as it’s tech companies that are showing greater interest in acquiring rather than serving these firms.

Looking to build their brand, these innovation firms are — “can gain an instant uptick in revenue growth from the acquisition,” as multifamily tool Lighthouse’s head of business development Sterling Weiss put it, having spoken recently with REITs who have been courted by such companies.

 

For now, technology companies are happy to transact with small- and mid-sized apartment owners and managers.

Twice this year, short-term housing platforms have made this happen. In January, The Guild purchased CREA Management and in March, Alfred purchased RKW Residential. The Brand Guild purchased CREA Management.

 

Both transactions turned the heads among a few in apartment management circles and many are looking to see what could happen next. Some industry observers see more such deals ahead.

It’s a potential win-win because these technology firms believe they can better drive net operating income at the property level.

They are finding the apartment industry is ripe for innovation and that there’s little better way to incorporate, help develop and test their technology through their own housing portfolio.

 

Data Scientists Find Niche in Property Management

Alfred reports that today on average, less than 1 percent of a property’s budget is put toward technology, unlike other innovative industries, which invest closer to 10 percent, based on recent research from Statista, McKinsey, and Deloitte.

For RKW Residential, the technology Alfred brought will make operations more efficient, RKW Residential’s Executive Vice President of Marketing, Joya Pavesi said.

“It’s been a bonus because we now have Alfred’s 40+ software engineers working on our behalf – that’s more engineers than what some of the biggest apartment operators employ,” she said.

The merger gives Alfred the chance to have executive oversight into how its technology is being used by its clients to ensure that its capabilities are being fully realized.

‘Keep A Very Close Eye’ on This Trend

Zain Jaffer, Investor, and Entrepreneur, Zain Ventures Jaffer says that these companies have strong incentives to acquire property management companies to scale their portfolios quickly.

“It’s clear that AI has the potential to completely reshape the nature of property management as we know it,” Jaffer said. “As more and more tech companies buy into the property management space, we will start to see some truly accelerated growth. I think this is a trend to keep a very close eye on.”

Todd Butler, Senior Vice President, Flexible Living, RealPage, focused on short-term rental platform Migo, points to “massive” NOI opportunities that owners demand – mixed with the residents’ need for flexibility to live/work/travel post-Covid – are now mutually at odds with “the way it’s always been done.”

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Source: Tech Companies Cast Their Eyes on Apartment Portfolios

https://www.creconsult.net/market-trends/tech-companies-cast-their-eyes-on-apartment-portfolios/

Apartment Players Are 'Holding Their Breath Despite Surging Rents

 

One leading apartment maintenance and construction distributor speaks out on pricing and inflation.

Even with the recent, steady rise in rents—by double-digits in many markets—that degree of revenue gains is unsustainable, apartment operator Mike Brewer, COO, RADCO Companies, Atlanta, recently said.

That brings the focus to expenses. And there’s not a lot of hope that prices will come down, or even what might bring them down, commented a vice president for one leading apartment maintenance and construction distributor last week.

 

“Distributors, manufacturers, and apartment operators are simply holding their breath right now,” they said. “There’s too much uncertainty with the economy, world events such as Ukraine and then some; and what happens if China suddenly shuts down and for how long. You might say things could get better with results from the 2024 US Presidential election, but even that’s too far and too much of a wild card.”

The distributor said that the supply chain is better but remains broken. Headwinds include recovery from events beyond just Covid, including weather, shortage of workers at ports and truck drivers; and not having the right technology needed to efficiently move containers along the path the best way possible.

Must Be Flexible on Brands

Apartment operators have said that they are left to be more flexible on product brands during this time, and this distributor described that predicament.

“You might want or need a Moen faucet, but then all of a sudden you can’t get it so you need to go with Pfister or some other brand. It’s unsettling, and appliances are the toughest product line to acquire right now, and for most of the past year or so.

 

“But we learned during the pandemic that our industry can be flexible and move on a dime. Manufacturers went from making a ton of faucets to making a ton of gloves.

“Let’s also remember that operators spent five years talking about self-guided tours, but didn’t do them. Then: Boom, they found a way to roll them out in a couple of weeks once lockdowns started back in 2020.

HVAC Systems Upgrades Coming

Upgrading and meeting changing regulations for HVAC systems and parts has created another difficulty.

“There are new regulations going into place right now where most jurisdictions are going to have to increase their SEER by one,” the distributor said. “Manufacturers are pausing some existing product-making as they transition to the new models. This will cause delays regardless of any other factor.”

And while pricing continues to be volatile, there are other factors in play that make pricing, availability, and now, budgeting, tough to figure.

“What we see is that the best customers can get the best prices,” they said. “Having existing strong relationships really does matter. We take care of our best customers, first.”

Passing on the Costs Hikes

The spokesperson said customers often ask how much of inflation the manufacturers and distributors pass along.

“If there’s a $40 item that now costs us $50, do we charge them that full extra $10,” they said. “And do we factor in other ongoing, rising inflation factors by pricing based on wages, gas prices, and anything else? The answer is, ‘It’s all variable, based on customer, item, and market?’

They said there also can be different prices for MRO vs renovation jobs.

“With a renovation job, we might have priced something six months ago and then that item goes way up in price,” they said. “Do we still honor it? If it’s a small customer or a small job, because we simply might not be able to eat that cost. It’s unfortunate.”

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Source: Apartment Players Are ‘Holding Their Breath’ Despite Surging Rents

https://www.creconsult.net/market-trends/apartment-players-are-holding-their-breath-despite-surging-rents/

Do Capital Gains Count as Income?

  You recently sold your house, your boat, or corporate stock for a tidy profit. But as you focus on plans for that extra money, along comes your brother-in-law, who shares an unexpected fact. Namely, the IRS considers sales-generated earnings as taxable income.

You scratch your head, wondering how this is possible. Undoubtedly, the IRS regards your salary, bonuses, and other on-the-job earnings as taxable income. But could that profit on your house, boat, or stock sale really count as income?

The answer to this question is yes. The profit you earn from the sale is a capital gain, which is a type of income. However, the IRS taxes capital gains differently from your take-home pay. As such, it’s important to understand the ins and outs of capital gains, to help you understand what you could owe when your taxes come due.

Defining Capital Gains

Earnings come from two sources, one of which is the above-mentioned take-home pay. The IRS places take-home pay under the category of “Wages and Salary,” or “ordinary income,” which also includes tips, commission, and bonuses. The taxes you pay on ordinary income depending on your tax bracket or how much you earn in a given tax year. The more you make, the higher your tax bracket.

Then there is the other earnings source, known as capital gains. You’ve probably realized that selling a capital asset generates capital gains. And as you’ve also likely discovered, capital assets consist of property acquired to create value over time, such as houses, boats, and stocks. Stamp collections, art, and baseball cards could also be considered capital assets.

Your capital gains are calculated by subtracting the sales price by the adjusted basis. Delving into the dictionary, “basis” is the original price you paid for that capital asset, plus additional expenses involved. For instance, if you make repairs to a house while you own it, your basis will include the original purchase price plus the added repair expense.

To reiterate, the IRS considers both take-home pay and capital gains as income. Both ordinary income and capital gains taxes are based on take-home pay. However, while ordinary income taxes can be as high as 37%, the tax rate on capital gains won’t reach higher than 20%.

How Long Do You Hold?

With the difference between capital gains and ordinary income in mind, let’s move on to the capital asset holding time. In fact, let’s say that you are a “house flipper,” someone who buys houses, fixes them up, and sells them within six or eight months. While you might earn a good profit from this action, it’s important to know that the IRS dubs those earnings as short-term capital gains. However, if you decide to own your investment houses for longer than a year, the IRS considers profits generated from their sale as long-term capital gains. What’s the difference? The IRS taxes short-term capital gains at the potentially higher ordinary income tax rate. On the other hand, your long-term capital gains fall under the possibly lower capital gains tax designation.

Additional Tax Issues

Now, once you’ve accepted that your brother-in-law knows what he’s talking about, the other piece of news is that the capital gains you earned from your house, boat, or stock sale will increase your adjusted gross income or AGI.

Returning to the dictionary, AGI consists of your total gross income, less specific deductions. Adding capital gains to that total could push you into a higher tax bracket. But once again, those capital gains are taxed differently from ordinary income, depending on when you sell your capital asset.

All Income is Not Created Equal

Anything you earn -- whether salary or asset sale -- is considered taxable income in the eyes of the IRS. However, much as you can reduce ordinary income through approved tax deductions, it’s possible to reduce or defer capital gains taxes through reinvestments, exchanges, or other shelters. In short, the more you understand the ins and outs of capital gains and ordinary income, the better prepared you are to lessen your potential tax hit.

To learn more about this topic, contact us today.

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Source: Do Capital Gains Count as Income?

https://www.creconsult.net/market-trends/do-capital-gains-count-as-income/

Getting Acquainted with Delaware Statutory Trusts (DSTs)

 

The COVID-19 pandemic has real estate investors questioning their portfolios' makeup, interests in managing properties, and long-term objectives. Delaware Statutory Trusts (DSTs), in which investors own shares in a trust rather than full properties, may contain some of the answers. more

DSTs are passive real estate investments run by professionals who manage property acquisitions and day-to-day operations. They often contain relatively low minimums, making them accessible to many real estate investors.  

The History Behind DSTs

The state of Delaware originated DSTs with the Delaware Statutory Trust Act of 1998. DST trustees and investors do not need to reside in Delaware, but they will file a trust certificate with the state when forming a DST.

Once a little-known trust structure, DSTs gained broader appeal with a 2004 Internal Revenue Service ruling. The IRS said, “A taxpayer may exchange real property for an interest in the Delaware statutory trust described above without recognition of gain or loss under § 1031 if the other requirements of § 1031 are satisfied.” The IRS essentially made it possible for passive investors to own fractional shares in a real estate trust and opened the door for DSTs to be included in 1031 exchanges.

A DST in a 1031 Exchange

A 1031 exchange makes it possible to sell one real estate investment and reinvest the proceeds in a like-kind investment of equal or greater value to defer capital gains and depreciation taxes.

While some investors will relinquish one property and choose a single replacement property, the opportunity to invest in a DST gives investors an important tool to diversify holdings, have an interest in large-scale institutional holdings that may otherwise be too expensive, and serve as a backup replacement property if originally identified properties fall through.

Key Benefits of including DSTs in a 1031 Exchange

DSTs can have investment minimums as low as $25,000 and can be combined with other properties in a 1031 exchange. Investors aren’t required to qualify for property loans or establish and maintain a limited liability company (LLC), an expense that can run $1,000 annually, opening the door for investors to have a stake in multi-unit apartment complexes, and commercial office buildings, and other property types.

1031 exchanges require like-kind replacement properties to be identified within 45 days of closing on the relinquished property and close on the replacement properties within 180 days. It’s possible to identify and complete a DST investment in less than five days, making it an ideal backup plan in a 1031 exchange for those up against deadlines.

Professional Property Management

Investors don’t need to be up against a deadline to find DSTs appealing. For many investors, the biggest DST benefit is professional management. A property manager receives the call when a pipe bursts and figures out how to collect when a tenant is late with the rent. While those owning properties outright can always outsource maintenance and management responsibilities, the owner is ultimately the responsible party. Most DSTs are set up for investors to collect regular distributions for a steady monthly income and look to capitalize on the appreciation of assets at the time of eventual sale.

Points to Consider Before Investing in a DST

While DSTs offer various benefits, real estate investors should be sure to read the offering memorandum’s fine print.

DSTs are long-term, illiquid investments that often are set up to last five-to-10 years. DST shares do not trade on an exchange, and if an investor wishes to exit before the trust goes full cycle, they will either need to find other investors to purchase the shares or sell them on a secondary market.

Some fees are not part of an actively management property, including commissions paid to leasing agents, property management costs, and the trustee's fees at the time of sale.

All 1031 exchanges require a Qualified Intermediary (QI) to facilitate the exchange and ensure the investor doesn’t take possession of the relinquished property’s proceeds. The QI may charge approximately $1,000 or more, but an experienced QI can help find DSTs that align with the investor’s goals and help the process go smoothly.

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Source: Getting Acquainted with Delaware Statutory Trusts (DSTs)

https://www.creconsult.net/market-trends/getting-acquainted-with-delaware-statutory-trusts-dsts/

The Role of 1031 Exchanges in Estate Planning

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Completing a 1031 exchange can allow real estate investors to defer taxes today and plan accordingly to avoid burdening their heirs with a hefty tax bill later.

A 1031 exchange involves selling a piece of real estate investment and reinvesting the proceeds in a like-kind real estate investment of equal or greater value to defer capital gains and depreciation recapture taxes ultimately.

The possible tax benefits that the 1031 exchange may offer, in combination with the option to divide assets appropriately to benefit heirs down the line, make 1031 exchanges an estate planning strategy worth considering.

Step up in cost basis

While there are reasons a real estate investor would want to sell a property in a standard transaction and pay the required taxes, this path could cost the investor upwards of 30-40% of the profits, which go straight to the IRS.

In a 1031 exchange, taxes on the gains on the relinquished property are deferred. Neither the estate nor beneficiaries face a tax liability upon the owner's death. Instead, the tax basis for the real estate investment that heirs inherit steps up to the fair market value of the date of death when they take possession. If they decide to sell the asset immediately, they will not owe capital gains taxes. They also will not be responsible for any of the depreciation recapture from which you may have benefited over the lifetime of your investment.

If the heirs wish to retain the asset, they would only be liable for taxes on gains in the future that accumulated as of the date they received the step up, up until when they sell the property. They might even consider including the property in a future 1031 exchange to defer taxes and reinvest the proceeds to defer that gain too.

Swap ‘til you drop

When investing in real estate, the properties you currently own may not be aligned with your investment objectives down the road.

It is possible to enhance your real estate portfolio over time and, through 1031 exchanges, defer the taxes each time. There is no limit to the number of 1031 exchanges an investor can complete. Investors can “swap until they drop” so long as each transaction's intent is for long-term investment rather than solely tax avoidance.

It is an opportunity to keep your own investment goals as the priority and use previous growth to have further compounded growth while also positioning your portfolio to benefit your heirs.

When there are multiple heirs

For investors who plan to leave assets to multiple heirs, it is possible to consider their financial situations when structuring your 1031 exchange.

As part of the exchange, investors may purchase multiple, or in some cases, an unlimited number of properties, setting the stage to leave different assets to different heirs. For example, let us suppose one heir will likely need to sell the investment after taking possession while another might want to hold the asset. In that case, it is possible to make it easy for both by purchasing multiple properties and listing each heir as a beneficiary of an individual asset.

Keep in mind that replacement properties must be identified within 45 calendar days after selling the relinquished property. It is viable to identify up to three replacement properties. Still, that limit can be surpassed so long as the replacement properties' value does not exceed 200% of the relinquished property, or the investor closes on at least 95% of the value of the replacement properties identified.

Consider a Delaware Statutory Trust (DST)

A Delaware Statutory Trust is a long-term passive real estate investment in which beneficial interests of a real estate trust are owned rather than individual properties directly. DSTs provide benefits for an investor's current situation by eliminating the headaches that come with active management properties while still obtaining all of the benefits of real estate ownership.

When it comes to estate planning, DST interests can be split among heirs, either ahead of time when purchasing the interests through the purchase of multiple of the same DST or upon death via reregistration based on instructions of Will’s or Entity documentation. This streamlines decisions while defusing potential estate conflicts. Investors should be aware that DSTs are typically designed to last five to ten years, and there is no active secondary market for investors should they need to sell.

1031 exchanges offer benefits for individuals looking to maximize their real estate investments today while setting up beneficiaries to continue building wealth. We always recommend consulting your tax or financial professional regarding how 1031 exchanges may fit your situation.

To learn more, please contact us at any time.

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Source: The Role of 1031 Exchanges in Estate Planning

https://www.creconsult.net/market-trends/the-role-of-1031-exchanges-in-estate-planning/