Include or exclude Cap rate and DSCR in NOI?

[Harry Brooklyn]

Hi,

I am budgeting for the basics for my NOI (and taxes, insurance too):

1. Repairs
2. vacancy rates
3. CapEx
4. Property manager

All of these factor into my CoC returns, but actually should they be factored into the NOI, which I need for Cap rate and DSCR?

[Chris McKay]

Quote from @Harry Brooklyn:

Hi,

I am budgeting for the basics for my NOI (and taxes, insurance too):

1. Repairs
2. vacancy rates
3. CapEx
4. Property manager

All of these factor into my CoC returns, but actually should they be factored into the NOI, which I need for Cap rate and DSCR?

Yes, absolutely. They're legitimate factors and expenses that must be included in any NOI calculation.

Unless you're a sell side agent and want to play with the numbers to make it seem like the property cash flows when it really doesn't. Lol.

[Evan Polaski]

@Harry Brooklyn, there is a difference between NOI and cash flow. CapEx has an impact on Cash flow, but not NOI. Capital items are considered non-recurring items, so are non-operating.

By definition and generally accepted accounting principles (GAAP) you should not include these in NOI.

As for your DSCR and Cap rate, again, I would argue technically, they are not calculated in, but often banks will include some form of recurring capex reserve contribution into their DSCR calculation.

So, should you consider these items in the evaluation of an asset, YES! 100%. They will effect your Cash on Cash returns, But they are not NOI, they are below the line impacts to cash flow. The same as interest expense and amortization impact cash flow but not NOI. Or interest rate caps, or partnership level expenses, etc.

[Harry Brooklyn]

Hi Chris - I realized I wrote a mistake. I know they all are important for NOI and cashflow. What I meant was should Cap Ex and a property manager be factored into computing Cap rate and DSCR?

Cap rate is more for performance of a building, where CapEx is more for reserves. DSCR is what a bank would calculate so I'm unsure if the bank would use CapEx and a property manager in their calculations.

I want to make sure I'm using apples-to-apples comparisons.

[Harry Brooklyn]

Quote from @Evan Polaski:

@Harry Brooklyn, there is a difference between NOI and cash flow. CapEx has an impact on Cash flow, but not NOI. Capital items are considered non-recurring items, so are non-operating.

By definition and generally accepted accounting principles (GAAP) you should not include these in NOI.

As for your DSCR and Cap rate, again, I would argue technically, they are not calculated in, but often banks will include some form of recurring capex reserve contribution into their DSCR calculation.

So, should you consider these items in the evaluation of an asset, YES! 100%. They will effect your Cash on Cash returns, But they are not NOI, they are below the line impacts to cash flow. The same as interest expense and amortization impact cash flow but not NOI. Or interest rate caps, or partnership level expenses, etc.

Thanks Evan, that's what I was thinking but wasn't sure of.  Many things after cashflow, but less for NOI.  So is the main items for NOI:
1. operation expenses (i.e. owner responsible utilities)
2. property taxes
3. insurance
4. maintenance & repairs
5. vacancy rates
6. snow plowing  (or is this until maintenance?)

* I usually set #4,5 at 5% of gross income

[Evan Polaski]

@Harry Brooklyn, you have a pretty good list there.  You could likely break things down further, but at the end of the day, your broad categories are covering it.  

As for flat percentage: I am not a big fan of that, personally.  Why?  Contractors don't really care if you are collecting $2,000/mo in rent or $500/mo in rent.  A drywall patch, mud and repaint will cost your, say, $300 regardless (I know the size of the hole matters, but your rent doesn't).  Same with replacing a cabinet or door, etc.  

And of course, age of building matters too.  Older roofs, statistically, will need more repairs.  Older HVAC the same.  

Maybe you have already accounted for some of this nuance with your percentages, but I see too many on these forums underwriting every deal the same, which simply isn't how it works in the real world, especially if you only have say 1 to a 100 units, where each expense has a bigger impact on the overall portfolio.

[Jacob Sherman]

unfortunately if the DSCR only principal interest taxes insurance and any applicable HOA or assessments

[Chris McKay]

Quote from @Harry Brooklyn:

Hi Chris - I realized I wrote a mistake. I know they all are important for NOI and cashflow. What I meant was should Cap Ex and a property manager be factored into computing Cap rate and DSCR?

Cap rate is more for performance of a building, where CapEx is more for reserves. DSCR is what a bank would calculate so I'm unsure if the bank would use CapEx and a property manager in their calculations.

I want to make sure I'm using apples-to-apples comparisons.

Sorry for the late reply. So, the answer to your question here is generally yes! That said, each individual lender will vary slightly in HOW they underwrite expenses for your DSCR, so it's very important to ask each potential lender about their process. This gives you the best heads up when going through options!

Hope this helps,
Chris

[Alex Hunt]

If it’s 5 or more units. Some lenders account for a 30% expense factor on top of tax, insurance. I would just include all of them and let the lender decide what to use so they have the full picture. 
Would be happy to take a look with this you!

[Robert Rixer]

CapEx is not included in NOI because it makes the property more valuable which lowers cap rate. If you have an old leaky roof, patching it (maintenance, include in NOI) does not improve the value at all. On the other hand, spending $30k to replace it with a brand new roof, in theory, makes the property $30k more valuable than the same place with the old leaky roof. Therefore its considered more of an asset and not an expense.