The Bottom Line

August 25, 2020

The bottom line:

It’s what investing in commercial real estate is all about. Whether you’re buying, selling or holding, your property’s net operating income (NOI) is the number all investors are most concerned with. Odds are, if you’ve been in a holding pattern, you’ve been running your property tightly and managing expenses closely. Perhaps you’ve been waiting to adjust rents up because you’re currently enjoying the best occupancy rates in years, and you fear that a slight change could upset the growth you’ve been experiencing in your net operating income. It feels good and, in fact, your property could be performing better than ever. This increase in NOI, combined with confidence in the industry, may signal to you and your investors that right now might be the time to sell. The investment sales market is currently booming right now and if you’re considering selling, right now could be the right time. Your total return on investment after selling could truly be a significant number. Investor demand is as high as the market peaks of the mid-2000s. So, let’s discuss your bottom line again because it will never be more scrutinized than it will be when your property is introduced to the market. The NOI you’re currently enjoying due to increased occupancy and tightened budgets will likely not be the same NOI that is used by brokers, buyers, bankers, and appraisers. When considering the sale of your property, there are three questions one should ask regarding the property’s NOI: 1) Is it defendable? 2) Is it sustainable? and 3) Is it financeable?

Is it defendable? When selling your property, the property’s financial statements will be reviewed with a fine-toothed comb. The tightened expenses will be scrutinized line by line and could be adjusted to account for differences in operating procedures of future owners. The rents will be compared with that of your competitors, and so will your vacancy allowance. If either number is too aggressive, an investor will underwrite to a more conservative number. Also, if you haven’t raised your rents before the sale, it will be difficult to convince an investor to adjust them upward. So, engaging a good broker who knows the market can help you realize any pent-up value. Your additional revenue sources will need to be well documented to get a favorable credit to your bottom line, and may be capitalized at different rates depending on risk. While the NOI may be adjusted at sale from how you are currently operating, that doesn’t always mean you’ll get a lower price. A truly defendable NOI will attract more investors to the offering and create a common ground on which to negotiate. A well underwritten property will mean less risk to an investor as well as a lender. Lower risk means investors will likely be willing to earn a lower return on investment and achieve more favorable financing; ultimately, that means a higher price for you.

Is it sustainable? During the due diligence process, an investor will compare your property’s performance with the rest of the market. Research regarding future construction of competing properties and market absorption will be analyzed to determine how sustainable income levels will be for the future of the property. Management companies and brokers will be interviewed to help investors identify economic trends in the market that could affect occupancy levels in the short and long term. An investor will also review your management, marketing, additional income, and multiple other line items to determine how stable your bottom line will be for years to come.

Is it financeable? Ultimately, a lender and an appraiser will look at all of the same items an investor would consider when purchasing a property but with a more skeptical eye. If you’ve done your homework to determine if your NOI is defendable and sustainable, then the next most important part of the sales process is selecting a qualified buyer who can pass through the scrutinizing eye of a lender.

In summary, your property’s NOI will likely be calculated differently depending on who is doing the analysis. The seller wants to inflate the NOI and the buyer wants to push it down. It’s definitely a game of give and take but as your strategy unfolds, keep in mind that your bottom line must be defendable, sustainable, and financeable.