Defining Net Operating Income and Net Cash Flow

11 Replies

Hey BP community after skimming through the forums I noticed a common thread, net operating income (NOI) is frequently confused with net cash flow (NCF), so let's clear it up! Since we are in the Multi-family (MF) forums, we will look at this from a MF perspective. Let's say we have a property bringing in monthly rents, let's call that gross income or, if vacancy and other credit losses are included, we will call that effective gross income (EGI). Then, we move to expenses. Expenses include any necessary expenses to run the property. These expenses commonly include, repairs/maintenance(NOT Capex, we will get to that later), administrative, property tax, property insurance, property management, etc. These are all expenses. Now refer back to the beginning when we had EGI or gross income. If we subtract expenses from our Gross Income we get our NOI (Income-expenses=NOI). Notice we have not yet included debt service (loans/financing, etc) or capital reserves. So if we take capital expenditures/reserves, debt service and depreciation from our NOI, we get our net cash flow (NCF). This number can vary greatly, so it is necessary to know what your goals are in order to interpret these numbers. It also helpful to break down your NOI per unit to help analyze the property. Ex: NOI/total # of units=NOI per unit, same works with NCF. One last thing, the why. Why is this important? Well it may not be. An example where it would be is when dealing with banks/lenders they look at specific ratios when looking at these numbers. Hope this helps, please comment with more questions.

Nice write-up, @Adam Franco , and you are correct that there is a lot of confusion related to some of the terminology used in real estate.  That's what makes BP so great...people getting started have this great resource to turn to in order to learn.

I'm right there with you up to the definition of NOI, but there is one correction to make to the definition of Net Cash Flow. From NOI you would subtract capital expenditures / reserves and debt service to arrive at NCF. Separately, you would subtract depreciation, amortization, interest and non-operating expenses (such as partnership level expenses) from NOI to arrive at Net Income (which is distinctive from Net Operating Income and is most relevant to tax preparation).  Depreciation isn't a component of the calculation of Net Cash Flow, as it is a non-cash item.

That's a loaded question, @Danny Randazzo .  It depends on what you are doing.  Investing for yourself personally?  Syndicating the deal by raising money from investors?  And it depends on strategy.  Are you most interested in cash flow or appreciation?  Or if you are syndicating, which are your investors most interested in?

But you asked how I look at it, so I'll answer it that way.  I fund my acquisitions by raising money from investors.  My investors are looking for cash flow primarily but also want some back-end appreciation.  So I look for the deal to throw off a cash-on-cash return (cash out each year divided by total cash committed) averaging in the 8% range.  I also look for it to throw off at least 6% by year 2 and climbing to 8% or greater by year 3, and getting to double-digits by year 5.

I also look at the IRR over a 10 year hold, 5 year hold, and 3 year hold, looking for at least a 14% IRR (net to investor after all splits and fees) over 10 years and higher IRRs for the shorter holds. On an asset level (meaning before sponsor splits and fees) I like to see IRRs in the 18%+ range levered and 8%+ unlevered.

@Brian Burke I have alway admired how you can cut to the heart of a conversation and make is as clear as a bell.  I suppose that is why you have more votes than posts.  

However, I had to read your post three times to try to figure out how net income came in, confusing the issue.  I guessing that if it confused me, other will follow suit.

@Adam Franco you explanation was great except for two points. One Brian pointed out with depreciation. You did a great job explaining EGI, but then "If we subtract expenses from our Gross Income we get our NOI" you used gross income instead of EGI.

Brian used the term cash on cash which of course includes ALL of the funds committed to the deal, not including the debt side.  This could include closing cost, syndication costs, up front reserves for capex budget, down payment(equity part of the acquisition), lenders fees, etc. Amazingly when a broker typically calculates the cash on cash, they usually only use the down payment.

Originally posted by @Jeff Greenberg :

 However, I had to read your post three times to try to figure out how net income came in, confusing the issue.  I guessing that if it confused me, other will follow suit.

HA!  I screwed that one up, @Jeff Greenberg.  BP needs to dock me some votes. LOL. (But thanks for the kind words).

Net Income has little use other than for tax prep. What I should have done was saved that description for last, which would have allowed continuity from the NOI calculation to the NCF calculation. Sticking Net Income in between my description of NOI and NCF made the whole thing confusing.

My point was to point out where depreciation actually belongs...as it has nothing to do with neither NOI nor NCF (just like my description of NI had nothing to do with either, either).

Hey @Brian Burke thanks for the clarification. I need to stay away from late night posts! I meant to leave those out and save for a later post as depreciation and items as such can cause additional confusion.

@Mauricio Ramos

Yep, got it. Right now I invest for myself and I'm not syndicating. I have a fund for capex that is separate. However, I care mostly about 1) how much cash I have in the deal once I'm done with it and 2) how much cash flow I actually get after expenses. I'm not saying that all these metrics are not important because they are. But I think when you're doing your own investments you can focus on the metrics that matter to you and not calculate every last thing. Also, once you know your asset you will know exactly what numbers you should use in your projections when you buy a similar asset. 

Great input @Lee. My wife and I were just having this discussion. Analysis paralysis has kicked my butt the past 6 weeks. We determined a clear criteria of what we are looking for and not obsessing over finding a “better deal”