Cash on Cash and Net Operating Income (NOI)

Net Operating Income (NOI)

Net Operating Income (NOI) is one of the many figures used to evaluate a potential investment and measure the ongoing performance and value of an asset. Just like the other real estate metrics we have explained on this blog, NOI should not be viewed in a vacuum, and it is best used in conjunction with other measurements as well as a full view of the different perspective of a buyer, seller, and/or investor.

Gross Revenue (accounting for economic vacancy)

Gross Operational Expenses

= NOI (Net Operating Income)

As others have noted, NOI gets at an aspect of multifamily real estate investment that distinguishes it from smaller assets like single family homes. There is a measurable income associated with a multifamily property, and the investment does not rely solely on the appreciation of the property value. One major difference between commercial multifamily (5+ units) and residential real estate (>5 units) is that commercial multifamily is valued based on the NOI generated and not only from comparable properties in a market.

What does Net Operating Income Measure?

Net Operating Income (NOI) measures, as you might guess, the operating income minus the operating expenses of a real estate property. The income, in this case, includes rent as well as any other income from things like laundry facilities, pet fees, fees associated with amenities, parking revenue, and any other money coming from the operation of the property.

The “Net” part of net operating income brings in the other side of the measurement, the costs incurred in the operation of a property. This list can have more variety than the larger discrete groups of property revenue simply because asset and property management of a multifamily building addresses a wide range of needs. These include repairs, property taxes, utilities, landscaping, insurance, legal fees, and other costs related to the property and its operation.

So, if you take your operating income and subtract your operating expenses for a given period, you’ll have your NOI.

What Is NOT Included in Net Operating Income?

NOI, as mentioned above, refers to the operation of an asset, NOT the valuation, so appreciation/depreciation of a property is not included in this measurement. Neither does NOI factor in things like income taxes, loan amortization, capital expenditures (one-time expenses like major renovations or repairs to improve the property), debt service, asset management fees, and other expenses unrelated to the operation of the asset. These items are often deal and owner specific would make it difficult to compare one asset vs another.

Net Operating Income and Property Value

NOI measures the baseline performance of an asset, and it can be used to determine and evaluate the value of a given property. As we discuss in an earlier blog post, the NOI of an asset is closely linked to its cap rate and valuation.

For example, let’s take two properties that have the same cap rate. If one of them has a high value and low NOI, that property may not be worth the investment compared to one with a higher NOI. That being said, looking at these figures by themselves does not account for the location, history, and other aspects that might affect the valuation or success of a multifamily investment property. NOI is a fundamentally important measurement, but it is best put into use in conjunction with other metrics and methodologies.

Cash on Cash

Of the many fine real estate investment terms, “cash on cash” is almost poetic in its clarity. IRR and NOI are abstractions compared to the concrete image of cash on cash. It’s the cash you earn on the cash you invest. 

As a holistic metric that records returns, cash on cash has a different scope than NOI, accounting for credit structure and mortgage rates. Because cash on cash accounts for the cost of loan payments, a cash on cash measurement does not represent the same baseline value in the way that NOI does.

Specifically, cash on cash takes the net value of the incomes and expenses related to the investment (including the cost of loan payments) and divides that value by the amount of cash invested in the project. So, someone’s cash on cash return can be different depending on how much they invest in the property, the amount of debt they use to finance the investment, and the cost of borrowing. 

The cash on cash return can be measured on the project level, on the LP level, or at the level of the sponsor for a project, and the value can be different for each one due to however a partnership is structured. Just because these levels are different does not mean that one investor necessarily will always gain more from an investment than someone who invests at a different level. These differences can reflect the increased risk of higher investments and the amount of work that goes into managing a multifamily project.

Cash on Cash and NOI: Works Well with Others

Using cash on cash and net operating income along with IRR values, cap rates, and a sound understanding of different property classes is a large (but not complete) part of the refrain I’ve kept repeating throughout these paragraphs: One number alone is not enough, and the more you understand how these concepts are formulated and interact with each other, the better you will be at understanding any single one of them. 

One number won’t do it all, and one person can’t either, which is why Gray Capital is so committed to sharing our knowledge and expertise to lead investors to success in multifamily and other commercial real estate investments. Click the button below to get started with Gray Capital and receive valuable information and the latest multifamily news and reports.

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