Hello - I'm having trouble understanding why we don't include the mortgage payment in the monthly expenses when we calculate the NOI. This is the formula as I understand it. NOI = annual rental income - annual expenses( excluding mortgage payment) Is this correct?
Every time I do this calculation I get a large NOI, or so it seems to me. So I think I must be missing something.
Any clarifications or insights would be greatly appreciated.
Yes, that is correct.
Every owner might finance the property differently. Some might pay cash. Some might have seller financing. Some might use agency debt or other mortgage. NOI's primary use is a measure of the value of the property. If the valuation changed depending on the financing used, it would become an useless measure for value. Because NOI is a measure of value, it helps for calculating equity gain of a project, but does not tell you total return. People also look at cash-on-cash returns which does take into account financing.
FWIW, I see a lot of people on BP use NOI and Cap Rate when discussing single family, duplexes, triplexes and quads. NOI and Cap rate are irrelevant to those types of properties because they are not used to calculate value of the property. Those types of properties are all valued using the Comparative Market Analysis (comps) approach.
Excellent. Thank you for the response, fellow Michigander! If I could also ask a follow up question - Is there a proportion or ratio or other target range or figure that we should have for the NOI? I'm looking at a condo at the moment.
From lender's point of view, NOI is the money available to service the loan. And this relates to another term DSCR ( Debt service coverage ratio). DSCR = NOI / P&I. For residential investment property, lenders require DSCR > 1.1. For commercial properties, most lenders require DSCR > 1.25.
NOI is also important when valuing the property if it is done for either a commercial loan or sale. Your mortgage, unless the buyer assumes the loan, will be very different for the buyer. Its important for them to know the expenses of the building, then they can make decisions about their financing and such.
In harmony with Greg's comment, NOI and Capitalization rates are used in evaluating properties of 5 units or more. If you're using it for a condo, that may be why the number doesn't seems right.