Suneet Singal on net operating income

Suneet Singal has a published background in real estate and corporate finance, so net operating income is explained here as a term, not as a personal result. Filings on this site record a chief executive officer departure from FC Global Realty Incorporated effective 2 January 2018 and an acting chief executive officer appointment at First Capital Investment Corporation effective 12 September 2017. A filing can name an officer. It does not compute a building's income. Net operating income is what remains from property revenue after operating expenses and before debt service and income taxes. You will find a line with that name, or a line that quietly means it, on offering memoranda, appraisals, and loan spreadsheets. This entry builds one labeled hypothetical, says what the statement ought to show, and separates that line from taxable income and from cash left after the loan.

The line the rate is built on

Net operating income, often shortened to NOI, is property revenue that you expect to collect, minus the operating costs of running the property. It stops before loan payments, before depreciation, and before income taxes. That stopping point is the reason a capitalization rate can use it. The rate is a relationship between this income and a price. If the income line has already had the loan subtracted, you are no longer holding the figure the rate is defined on. Say the name of the line out loud and then look at the rows above it and the rows below it.

The path into the line is ordinary. Potential rent is the rent if the space were leased on the terms you are using. Vacancy and credit loss reduce that potential. Other income, such as parking or laundry in a hypothetical multifamily budget, is added if the property actually earns it. Expense reimbursements from tenants are added if the lease makes the tenant pay a share of costs. Operating expenses are then subtracted. What remains is net operating income, provided you have not tucked debt service or a partner's distribution into the expense list.

Two honest statements can still disagree. One person deducts a reserve for replacements and calls the result NOI. Another leaves the reserve below the line and uses a higher NOI. One person imputes a management fee because the owner manages the building without a bill. Another uses a fee of zero because no check was written. Neither person has necessarily made an arithmetic error. They have used different boundaries. A reader who compares the two percentages without matching the boundaries is comparing unlike lines. Ask which boundary the page used before you quote it.

A labeled hypothetical statement

Use a hypothetical year, not a real building. Potential rent is $1,200,000. A vacancy and credit-loss allowance of $60,000 is a figure chosen for the example, not a published market rate. Other income is $40,000. Effective gross income is $1,180,000. Operating expenses for taxes, insurance, utilities, repairs, payroll, contracts, and a management fee total $380,000. Net operating income is $800,000. You can check that by subtracting: $1,180,000 minus $380,000 is $800,000. If a page prints $800,000 and the lines do not add to it, stop and find the missing row.

Now put a reserve next to that result. A hypothetical replacement reserve of $40,000, if deducted before you name the income, produces NOI of $760,000. Same rent, same operating bills, two names if you are careless. Label them. "NOI before reserve, $800,000. NOI after a hypothetical reserve, $760,000." A capitalization rate applied to the first figure is not the rate applied to the second. At a hypothetical price of $10,000,000, the first rate is 8 percent and the second is 7.6 percent. The building in the example did not change. The definition did.

Debt service does not belong in the subtraction that creates NOI. Suppose the hypothetical annual loan payment is $500,000. Cash after that payment, starting from the $800,000 figure and ignoring the reserve and any capital project, is $300,000. That $300,000 is not net operating income. It is a cash figure after financing. If someone labels it NOI, every later cap rate, debt-service coverage ratio, and comparison is off by the loan. Circle the label on the page. Relabel it in your notes if the rows show a loan payment above the total.

What the statement should contain

A statement you can use names the period. "Trailing twelve months ended March" is a different object from "calendar year budget" and from "annualized last month." One unusual month, annualized, can invent a year that never happened. The page should also say whether the figures are cash or accrual. A tenant who was billed in December and paid in January lands in different periods under those two methods. You do not have to redo the books. You do have to know which method the total used.

Look for a gross-up of reimbursements. In many net leases the tenant pays a share of expenses, and both the expense and the reimbursement appear, one in costs and one in income. If the author put the reimbursement in income and left the expense out, NOI is high by that amount. If the author put the expense in and left the reimbursement out, NOI is low. The gross and net leases entry is the place to see why the lease, not the nickname of the lease, decides which of those rows exist.

Non-recurring items and related parties need a note, not a silent blend. A one-time insurance refund, a one-time professional fee that will not repeat, or rent paid by an affiliate at a figure no one else would pay, each changes the line. The note can be a sentence: "Included in other income: a hypothetical $25,000 refund we do not expect to repeat." The reader can then show NOI with and without it. A clean total that hides a non-recurring item is harder to use than a messy total that labels it.

Items that usually sit below the line

Capital projects are the usual argument. A repair that keeps the property in ordinary condition often stays in operating expenses. A new roof, a new system, or a renovation that changes the property is often treated as a capital item and does not reduce NOI, though it does reduce cash. Practice varies, and a reserve is the tool some appraisers use so that a capitalized income figure is not blind to replacements. The page should say whether the roof you can see was expensed, capitalized, or reserved. The cash you will write does not depend on the label, but the cap rate does.

Loan payments, partner distributions, income taxes, and depreciation sit below NOI in an underwriting presentation. They matter. They are simply answers to different questions. The loan payment answers what the lender is owed. The distribution answers what the agreement lets the owners take. Depreciation answers a tax timing question and is explained for tax purposes in IRS Publication 946, not in the rent roll. If a spreadsheet folds all of them into one "net" number, split them back out before you compare the property with another property that was drawn on the standard boundary.

A debt-service coverage ratio uses NOI in the numerator and debt service in the denominator. In the hypothetical, $800,000 divided by a $500,000 payment is 1.60. That ratio is a test of cushion against the payment you assumed. It is not NOI, and it is not a cap rate. The lender's term sheet, not a handbook, states the test the lender will actually apply. The OCC's Commercial Real Estate Lending handbook explains why examiners look at property income and debt service. It does not set your ratio for you.

Taxable income is a different statement

A tax return for a rental property starts from rents and expenses and then follows tax rules. IRS Publication 527 discusses residential rental property, and Tax Topic 414 discusses rental income and expenses. Those pages are about federal tax reporting. They are not an underwriting template. Depreciation, the choice of entity, and the treatment of some costs can make taxable income differ from the NOI an appraiser capitalizes. Quoting taxable income as NOI imports the tax return's rules into a ratio that was not built on them.

That difference runs in both directions. A cash expense the tax rules require you to capitalize will reduce cash and may not reduce this year's taxable income in full. A depreciation deduction can reduce taxable income without a check leaving the building that year. If you are trying to know what the property produced from operations, start from the rent roll and the bills. If you are trying to know what the return reports, start from the return and Publication 527 or 946. Label the sheet so a later reader does not merge them.

This page is not tax advice. It does not estimate anyone's tax, and it does not tell you whether a cost is deductible. It tells you to keep the underwriting line and the tax line in separate columns, and to read the IRS pages when the question is a tax question. A hypothetical NOI of $800,000 is not a hypothetical taxable income of $800,000. Say so on the page where a colleague might assume they are the same.

Usual mix-ups

The first mix-up is the nickname. "Net income," "net cash flow," "earnings," and "NOI" get used as if they were one word. On a property statement they are not. Ask to see the last expense above the total and the first item below it. If the last expense is a management fee or a utility bill, you may be looking at an operating line. If the last item is a mortgage payment, you are looking at something after debt. Rename it in your notes to match the rows, not the heading someone typed in a hurry.

The second mix-up is the missing fee. An owner who manages the building may pay no third-party manager. An appraisal often still deducts a market management fee so the income can be compared with buildings that do pay one. A broker's trailing statement may omit the fee because it was never paid. Both can be faithful to their purpose. Comparing them as if both were "the" NOI favors the statement that omitted the fee. In the hypothetical, a 3 percent fee on $1,180,000 of effective income is about $35,400. Leaving it out does not make the building more profitable. It makes the presentation incomplete if the buyer will have to hire a manager.

The third mix-up is annualizing a good month or a bad one. A December that includes a prepaid quarter of rent, or a February with a burst pipe, is a poor stand-in for a year. Trailing twelve months will not cure a permanent change, such as a tenant who left, but it will keep one month from masquerading as a run rate. If the only statement you have is a single month, say so, and do not print a cap rate as if the year had been observed. Multiply by twelve only as a labeled sketch, and go get the rest of the months.

What the line cannot prove

NOI cannot prove that next year will match this year. Leases expire, taxes get reassessed, insurance is repriced, and a vacant unit may or may not be leased on the terms in the pro forma. The line is a constructed total for a stated period. It is not a promise. It also cannot prove that cash will be available to distribute. Capital projects, reserves, debt service, and the partnership agreement stand between NOI and a check to an owner. An $800,000 line and a $300,000 cash figure after a hypothetical loan can both be true. Only one of them is spendable in that simplified example, and even that one ignores taxes and capital items.

The line cannot prove a price by itself. Price comes from dividing the income by a rate, or from sales, or from a negotiation. The income is an input. People who already like a price will sometimes solve backward for the income that makes a desired rate appear. That is arithmetic, and it is also a warning. If the rent roll and the bills do not support the income that the desired rate requires, the rate is decorating a wish. Tie the line to what a capitalization rate measures only after the line itself is tied to documents.

The line cannot prove a personal track record. Nothing on this page is an operating statement for a property owned by Suneet Singal, and the page does not claim he owns one. The career record is the place for the dated roles. Use NOI as a way to read a statement in front of you. If you do not have the statement, you do not yet have the income, however confident the headline percentage sounded.

What this entry does not claim

Suneet Singal’s published professional background is in real estate and corporate finance. Company filings linked from this site record a chief executive officer departure from FC Global Realty Incorporated effective 2 January 2018 and an acting chief executive officer appointment at First Capital Investment Corporation effective 12 September 2017. The Suneet Singal Scholarship, Grant and Giving websites describe him as the founder of those programs. This entry explains a general subject. It is not a private track record, a current job title, an investment result, or a quote.

This page is a reference, not investment advice. The line you just defined is the numerator in what a capitalization rate measures, and the bills inside it are itemized in operating expenses in a property budget.