Analyzing Beyond NOI - Three Things To Consider Part 1

You must know three things about the money you take in on a piece of real estate. When most people analyze a property investment, they start off with a number called Net Operating Income (NOl).  This is what your operating income will be after you deduct your operating expenses, but before you take into consideration your income taxes and any applicable interest. Investors make all their assumptions based on that number.  That means their analysis is based solely on the cash that’s coming in. They very seldom take into account any other critical factors about the cash flow. In reality however, you must analyze beyond NOI, and consider the following financial triumvirate for exact analysis of your real estate investments:• Quantity of income being produced

• Quality of the payer or the payee

• Durability of the income stream (how long will it last – term of the leases)

For example, if you have five tenants in a small retail building and all their leases expire on January 25th 2008, you may suffer quite an economic setback on that date if everyone leaves your property when their lease expires.  Of course, most of your tenants talk to each other, which gives them a relative amount of bargaining power with you.

When their leases come up for renewal, they might band together and say, “Well, we’re not sure about renewing our leases. It all depends on whether you’re going to drop our rent by $3 a square foot. You see we figure the market is going to be really terrible by next January.” Of course, the market will be personally terrible for you, if all five of those tenants move out. Even if just two of them move out, that’s a 40% vacancy!

Depending on how you have the property financed, it might be enough to put you upside down. Then, you’ll have to start writing checks to support the property, instead of having that property support you. This is why you have to analyze beyond NOI and also consider possible vacancies.

When you finally do the underwriting and decide just how much a property is worth, you need to look at what kind of people are paying that rent (quality). You should ask yourself questions like:

• Are your tenants big companies, small companies, or just individuals?

• How good is their credit?

• Do any of your leases expire at about the same time, so that you might be faced with multiple loses?

Key PointThe benefit of any real estate investment is the cash flow due to operations each year and that which is due to the sale at disposition. Keep track of these elements and measure them carefully as you analyze each of your real estate holdings. Look at the level of income as you conduct business and how much money you make when you dispose of a few properties. Eventually when you analyze a real estate asset, you must look at some expected holding period. A suggestion is usually about five years.

So remember, that there are other factors you must analyze beyond NOI, in order to make successful investment choices.

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