Question on digging into the details

[Kyle D.]

I am looking at an apartment and I noticed on the P&L the owner is including the mortgage interest as an expense reducing his NOI. I thought that should come after NOI. Is this a win for me?

[Frank Gallinelli]

Kyle -- This looks like a Quickbooks P&L, which is fine, but it is not what a real estate investor uses, which is called an APOD (Annual Property Operating Data).  The bottom line of the APOD is Net Operating Income, and it's the word "operating" that matters most. 

Strictly speaking, an APOD is not an accounting report. Costs that are not part of the operation of the property, therefore, are not relevant. So, you should not be taking any costs of financing into account and should not be looking at depreciation, either.  Neither of these is part of the operation of the property (i.e., you don't need a mortgage or a depreciation deduction to "operate" the property).  On the other hand, you should be subtracting an allowance for vacancy and credit loss from the gross income. Bottom line with this approach is the Net Operating Income.

The reason that it is important to follow these protocols is that the market cap rate you'll find in regard to other properties sold followed the same inclusions/exclusions. For your estimate of value, by capitalization of the NOI, to be relevant, it's essential that you follow the same.

Apples to apples, and all that.