Introduction
Understanding real estate income and expenses is crucial for making informed investment decisions. Real estate is an investment that relies on its anticipated cash flows net of federal, state, and local income taxes. Unlike comparable properties, a property’s immediate past operating history serves as the foundation for projecting the financial benefits of investment property. Consideration is given to anticipated changes in an economic, social, and political environment that affect the income-generating potential of the property. The analysis must also include a forecast of likely changes in the property’s market value over the anticipated holding period. Real estate operating statements report cash receipts and disbursements.
Revenue and Expenses
- Potential Gross Income: Amount a property can generate when 100% occupied without vacancy and collection loss.
- Effective Gross Income [EGI]: Adjusted potential gross income. Income less vacancy and collection loss plus income from other sources (e.g., laundry, parking, etc.). Historically, it is the actual gross revenue of the property.
- Operating Expenses [Op.Ex.]: Typically, in three categories.
- Fixed expenses [e.g., RE taxes, Insurance]
- Variable expenses [e.g., repairs & maintenance, utilities]
- Replacement reserves and capital expenditure
- Net Operating Income [NOI]: The difference between EGI and Op.Ex. Where there are no income taxes or other non-operating transactions like debt payment, this would be net cash flow to the equity investor.
Forecasting Revenue and Expenses
Forecasting the anticipated revenue of real estate is both science and art. It involves a review of individual leases to determine contract rental rates and determine lease concessions. Compare the subject property lease (abstracted salient lease terms) with comparable properties – often a valuable data source for estimating the subject operating history consistency with the market. The challenge is finding “true” comparable property; comparable property must function as a close substitute for the subject property. Attempt to verify information, if possible, by conversing with the property manager and building engineer. Published resources [IREM; BOMA, etc.] report operating expenses. While it is informative, it is less reliable than detailed information from comparable (substitute) properties.
Conclusion
The relationship between the net operating income (NOI) and the capitalization rate (cap rate) is the basis for the future market value of the investment property. Since the historical past performance is the “window” an analyst has to the “predicted” future market value, it is then important that a thorough investigation of typical market revenue and expenses of similar properties are conducted and compared with the subject property’s history of income and expenses for a credible result.
Our valuation experts at Veritas Realty Advisors are available to provide an unbiased and objective analysis of any use for which you need an appraisal. Let us use our knowledge of real estate asset class and market to work for you.
About Yomi Omotoso
Yomi Omotoso, MAI, RES, is a highly qualified and experienced professional in the field of real estate. As the Principal Appraiser at Veritas Realty Advisors, he brings a wealth of expertise in property valuation, litigation, feasibility appraisal, investment/development advice, and analysis of complex valuation issues. His areas of specialization include historic preservations, contaminated land, air rights, site selection analysis, and eminent domain. Yomi is a Certified General Appraiser in the State of Maryland, and he holds a Master of Science (MSc) in Real Estate from Johns Hopkins University, Baltimore, Maryland, a Bachelor of Science (BSc) in Estate Management from the prestigious Obafemi Awolowo University, Ile-Ife, Nigeria, and National and Higher National Diplomas from The Polytechnic Ibadan, Nigeria.
Contact Yomi at (240) 855-5628, or yomotoso@veritasreadvisors.com