As you start reviewing investments and many different financial documents, there are some key terms that you need to understand. There are four key terms that you need to know that will help you determine the performance and value of an asset.
Income and Expenses
While looking at a financial statement, you will see many different line items under income and expenses. There are two types of income when it comes to assessing a multifamily asset: operating income and one-time income. Operating income is income from day to day property operations like rents, parking, storage, and laundry. For one-time income there are a couple of examples like commissions by the Cable Company, and insurance payouts.
For expenses there are two major categories, operating expenses and Capital expenses. Operating expenses are from the day –to- day property operations like utilities, admin, payroll, marketing and unit make ready. Even though debt is an expense but debt is not included in the operating expenses. Capital expenses are the unit and property remodeling and major expenses that are non-reoccurring.
Net Operating Income (NOI)
Net operating income is the difference between operating income and operating expenses. NOI is a metric that shows how efficiently and profitable a property is being operated. This can be used to determine if a property is a good investment. Additionally, it allows for investors to know if the expenses are too high, rents are too low, or if a property is unaffordable. NOI also provides a big picture of the property for investors to determine if this particular asset is going well for their investment goals.
In the commercial real estate investing you will hear the term cap rate many times over. What is cap rate? What does it tell you and how can I use it as an investor?
First of all cap rate is the FIRST YEAR NOI divided by the price of the property (value). There are three different types of cap rates. First is the Market Cap Rate. This metric tells what investors are willing to pay for an income stream in that particular market. Secondly, we have the Property Cap Rate. This is defined as the current NOI by the acquisition or disposition price. A very important factor to recognize is that the NOI in the cap rate is for a stabilized asset. Acquisition cap rate plays a little role in a value add model.
Cap rates are the basis for real estate appraisals and you can compare cap rates of similar properties. Cap rates do not consider appreciation/depreciation on future income, risk, or leverage/mortgage terms. It is important to remember that cap rates differ between asset classes, and markets. It is only a snapshot of an asset and it can be affected by many different factors.