Analysing A Commercial Mortgage Loan: Net Operating Income

In my previous article we touched on the basic criteria that make a commercial mortgage loan a much different animal from a residential mortgage loan. In a nutshell, it is the fact that whatever loan amount is desired for an income producing property must be supported by the income that the given building produces. This leads us to the first most significant calculation:

Net Operating Income

When you are speaking to a potential borrower, one of the first, if not the first thing that you would ask is (after or at the same time as credit score): Do you know what the net operating income of the building is? Simply, the net operating income, or NOI, is the gross rents of the building minus the operating expenses of the building. Because the NOI of the building has to be able to support the desired loan, it is imperative to acquire to a really accurate number. This means that we do not necessarily rely on what the borrower is telling us, but look for verification. This is significant because any "inaccuracies" would come out during the due diligence process, so once again we do not prefer to waste our time on a deal that cannot be done. If actual expenses are higher than what we are being told, or actual rents are lower, this could turn what at first glance looked like a great deal into a deal that cannot be funded. A little legwork early in the process could save you a lot of time and effort later, as well as the experience of a deal "crapping out" late in the process.

What goes into the NOI calculation? We need the following:

Gross rents

Expenses

Property Taxes
Building insurance
Utilities

10% of the gross rents to account for management and vacancy

NOI = Gross rents - expenses

Very simple calculation.