A property's Net Operating Income (or NOI) is derived from its operating statement (a property's P&L). NOI is the actual or expected net income after operating expenses are subtracted from effective gross income, but before mortgage expense and depreciation. NOI can be calculated before or after subtracting replacements reserves.
NOI is important for multifamily lending because it indicates to the lender the amount of net income available for loan payments. Lenders will want a certain amount of cushion between net income and your mortgage payment. This is calculated as the debt service coverage ratio (DSCR). Generally speaking, they will want a minimum of 1.25x DSCR ($1.25 of net income for every $1.00 in mortgage payment).
Lenders will use this ratio to determine the maximum loan amount they will lend on a specific property. An incorrect NOI calculation can limit your loan amount and increase your interest rate.
An operating statement represents the various income and expenses related to a property over a specific time period. Income items include rent, laundry, parking, storage, RUBS and reimbursements. Expense items include management fees, utilities, insurance, repairs and maintenance, real estate taxes, landscaping, janitorial, trash removal, advertising, supplies, pest control, security and miscellaneous expenses. To ensure an accurate NOI, multifamily owners should avoid some common operating statement errors.
The most common operating statement mistakes are the inclusion of "capital expenditures" and "non-related expenses" as expenses. Capital expenditures are non-recurring expenses that improve the property, like a roof replacement, heavy unit turns, equipment or major repairs. These expenditures should be capitalized and depreciated but NOT expensed. Even if the tax approach allows you to depreciate these expenditures over the short term, they should not be considered "expenses" on the operating statement. Non-related expenses are expenses that are not related to the property. Examples of these include personal expenses or expenses for unrelated properties or businesses.
Another operating statement error to avoid is not including all recurring non-rent income. These include things like RUBS, laundry, storage, parking and any expense pass throughs. Be sure to add these as line items to the revenue portion of your operating statements so the lender can do historical analysis on these income items. Income items that generally cannot be counted are fee income (i.e. NSF fees, late fees and miscellaneous fees) and damage fees.
Please connect with your tax professional for guidance on what is a true expense and what are depreciable capital expenditures. If you have capital expenditures or non-related expenses on your operating statement, be sure to let your lender know so they can remove them to accurately calculate your net operating income.