The heartbeat of real estate investment is the Net Operating Income, ingloriously referred to as the NOI. The purpose of maintaining a critical eye on this seemingly mundane number is that your investment will rise or fall on its fluctuations.

A robust NOI will materialize all the financial dreams that are possible for your property. Conversely, a failing NOI will signal a property's waning financial health and instability dreaded by the most detached investor.

Why? The NOI is the number that most accurately demonstrates a property's financial operations. It is, as they say, the "bottom line."

To get a clear picture of the critical nature of the NOI we must look at the basic financial structure that governs all income property analyses:
Gross Scheduled Income (GSI)
Less: Vacancy
Plus: Other Income Equals: Gross Operating Income (GOI)
Less: Operating Expenses
Equals: Net Operating Income (NOI)
Less: Debt Service
Equals: Cash Flow Before Taxes
Less: Income Taxes Equals: Cash Flow After Tax

Simply put, the NOI is the result of the "income" less "expenses" prior to any deduction for mortgage payments and taxes. Income and expenses are the only contributors to the NOI. As such, their fluctuations will mandate its increase upward (Yes!) or downward (Oh, no!). To increase the value of an investment property we need only to increase the NOI.

In fact, the Net Operating Income is basic to computations for determining value. For instance, Capitalization Rates (cap rates) are one of the more commonly used techniques for assessing the value of an investment property. A cap rate is calculated by dividing

the NOI by the property's value ($48,525 NOI / $500,000 = 9.7% cap rate) or, a market value may be obtained by dividing the NOI by a cap rate ($63,432 / 9.5% = $667,700).

So if you own a property that generates a $63,432 NOI and want to sell it for $750,000, you must find an investor who will accept an 8.5% cap rate. If your investment property is in an 8.5% cap rate or less world, fine. Your property will sell. However, if the comparable sales for your property are 9.5%, it is likely that your property will languish on the market. Alternatively, if you can increase your NOI to $71,250 then you can get your price. Herein lies a magic wand of real estate investment.

When the question is "How can I get more money for my property?", the simple answer is, "Raise the income and/or decrease the expenses." Just because it is simple (do not confuse with easy), does not mean that it is unimportant.

Let's take a look at a 12 unit apartment building that has 11 two-bedroom units renting for an average of $600 a month and one three-bedroom penthouse unit renting for $900.
The GSI is $90,000, and after losses from a 5% average vacancy and a net income of $60 a month from laundry equipment, the annual GOI is $86,220. Expenses for the last year were $22,788 resulting in a $63,432 NOI. If comparable buildings are selling at a 9.5 cap rate and if the seller wishes to sell for $750,000, his problem is to increase the NOI to $71,250.

The path most taken is to increase rents... not a bad choice. "Hmm," the owner ponders, "if I can increase rents by 8.7%, I am home free! Let's see, this amounts to a monthly increase of, gulp, $50+ on the 11 units and, yikes, nearly $80 on the larger unit. Oh my goodness, isn't there another way?" (Let me editorialize here for a moment. Raise your rents regularly. Raise them annually for existing tenants and on every turnover. Modest, regular increases not only keep the value of the property increasing, it keeps you ahead of the expense curve (or is it curse?), and it eliminates the need to make large, unpopular increases.

Yes, there are other ways, but rent increases are vital to the health of the building. The owner, a regular subscriber to the HesseLetter, studies the market and determines that while the larger unit is at or slightly above the market rents, the two bedroom units could be raised to $650 and still be at market levels. However, he feels that this increase may balloon his vacancy rate to 6%. The added $6,600 of rent, boosting the GSI to $96,600 clearly offsets the anticipated $1,296 of increased rent loss to vacancy.

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