Should Cap-EX or Major Repairs be Factored into NOI?

Question

Hello All,

This is my first post in this forum. My two partners and I have 29 units varying from SFHs to 4-Plexes right now, so have not really looked at NOI on those.

A 16 Unit came up in our smallish but vibrant Midwestern town and I have been running some number on it.

My understanding of NOI is if there was no borrowing involved and we payed all cash, took the total income (which would account for vacancies already), subtracted our 'expenses' such as minor repairs, snow and grass, insurance, utilities, etc..... you would have your NOI. Divide that by your purchase price and you get your CAP rate.

The few things I am NOT sure of are: property management costs, cap ex budget/costs, or setting money aside for larger repairs that we could write off in a single year.

Please educate me on the details.

Thanks, Dan Dietz

Steve Hall · Answer

@Daniel Dietz

It really doesn't matter what the given NOI includes... you still have to run your own numbers and figure the true NOI. Many times the NOI you are given is a pro forma NOI (even if they don't state that it is pro forma!)

If the given NOI does not have PM in it, and you plan to use a manager, then when you run your numbers, add in PM and recalculate your NOI (and cap rate if you want to know it). If the current owner mows the law, and you don't plan on doing that, add in landscaping costs.

Sellers/listing agents like to omit as much as possible from expenses (PM, vacancy, evictions, CapEx, etc.) so they can list their property with a higher cap rate. Use your experience to look thru the expenses on their P&L and see what they are not disclosing. The "true NOI" is always lower than what is advertised.

Michael Le · Answer

It would be included. So it would kind of be like 'NOI minus replacement reserves divided by debt service equals DSCR'.

Michael Le · Answer

• property management costs - Yes, it is part of Operating Expenses
• cap ex budget/costs - It's not included as part of the OPEX and thus not part of the NOI
• setting money aside for larger repairs that we could write off in a single year - Replacement reserves is for the purpose of capital expenditures and thus you might think it is not part of the OPEX. However, lenders will keep replacement reserves above the line when calculating DSCR so keep that in mind when trying to size your loan.

Theo Hicks · Answer

Hi Daniel,

Property management fees (3% to 10% of collected income, depending on the property size) and reserves ($200 to $300 per unit per year) go into the NOI calculation. CapEx does not.

Tj Hines · Answer

@Daniel Dietz  There’s only one formula for NOI and that’s income - expenses. Capex is simply capex. In my opinion this shouldn’t be included in the NOI. Why? Once you’ve read enough T12s and understand avg expenses per door whatever market you’re in, you will better understand your proforma and how the property would operate

You can simply take out the perceived capex line items, then categorize as Capex/Major Repairs  (roof replacement or repair, re-plumbing, repave parking lots, ac, electrical, interior & exterior Reno)

Expenses (taxes, insurance, service contracts, management, utilities- wst, turnover, legal, maintenance, G&A, payroll)

Now take the income minus expenses. This is a true number. Your capex all should be put to the side as reserves in case something goes wrong.

Brian Metz · Answer

Yes CapEx and debt service below the line, PM costs and reserves above, like everyone has been saying! And don't trust any provided NOI - run your own numbers - it's a must. Joe Fairless' book on apartment syndication is excellent overall and talks to some of this as well.

Good luck on the 16 units!

Cheers,

Brian

Jared Carpenter · Answer

@Daniel Dietz

CapEx is below the line.

You should however consider a replacement & reserve figure above the line.

Up-front CapEx should be included when looking at your all-in cap rate.

Daniel Dietz · Answer

Thanks for all the replies so far. It is helping me get a much clearer picture.

@Michael Le, could you clarify;

"However, lenders will keep replacement reserves above the line when calculating DSCR so keep that in mind when trying to size your loan."

Does that mean what we would set aside for larger repairs would or would not be included when figuring expenses for the DSCR?

Thanks, Dan Dietz

Russell Brazil · Answer

By definition, CapEx is not a consideration in NOI.

Ed Matson · Answer

@Daniel Dietz - CapEx is not normally included in Op Ex, and thus not in NOI.  Management and major repairs like carpet replacement and turnover painting, etc.  are.  We look at expected cash flow and return on capital more than NOI, although NOI/Cap Rate is a nice number to compare properties on an apples to apples basis.  We budget for CapEx based on the condition of the building and our expected hold period.  And we use this budgeted number as if it were an actual expense to calculate cash on cash return.

Should Cap-EX or Major Repairs be Factored into NOI?

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