Hey Smart Guys/Gals - Question about NOI

[Brandon Turner]

Hey, I'm working on a spreadsheet and I'm wondering:

Does the Net Operating Income include deducting the costs for the "big items" that happen every so often, like roofs, parking lots, etc? I mean, if I set aside 3% per month for those big expenses that only occur once in a blue moon, do I include subtract that 5% as part of my expenses to determine NOI or no?

thoughts? Does it depend on the investor?

[J Scott]

There's no right or wrong answer here. From a pure accounting perspective, reserves for Capital Expenditures (Capex Reserves) are typically factored below the NOI line, not above.

What that means is that they are not considered part of NOI, just as P&I is not considered part of NOI. It looks like this:

Gross Income - Expenses = NOI

NOI - P&I - Capex Reserves = Net Cash Flow

Now, in the real world, I've seen it done both ways -- some investors factor it above the line (as part of NOI) and some factor it below. Oftentimes, sellers will factor it below the line (or not at all) so as to make the value of the property appear higher (value is proportionate to NOI).

On the other hand, as a buyer, you should either factor it into the NOI, or at very least, include it in your pro-forma analysis.

The funny thing is, I once asked an appraiser if -- when valuing a property from an income perspective -- they factor in Capex Reserves or not, he said that for commercial properties there is no appraisal standard to do it one way or the other. Not sure if that's really true or not, but that's what he said.

So, I guess the answer is, it depends on what you're trying to do. If you're trying to determine if a deal is good for YOU, factor it in, either into the NOI for value determination, or into the pro-forma for the analysis. But, if you're marketing a property and are communicating value, don't include it in the NOI, and allow the buyer factor it in himself.