NOI is one of the most common requests by institutional and family office investors. What does NOI mean? It means “net operating income”.
Most real estate firms use NOI to value properties. NOI gives a true sense of the cash flow at the property by using operating revenues and operating expenses. Anything below the line, meaning below NOI, is not in the normal course of operating the property and therefore, not used in the property’s valuation.
Let’s take a hypothetical situation to better understand what NOI means.
New Investor Requests NOI Details from Real Estate Firm
Perhaps you landed a job at CALPERs. You go, Glen Coco! That’s a huge win.
As part of your job, you need to assess GPs, aka real estate firms, to understand potential investment opportunities in their funds or other vehicles. You will want to understand the investment vehicle’s overall returns as well as individual real estate investments’ performance. That’s because different funds or vehicles will have unique waterfall structures that impact how much you, the investor, get paid.
These waterfall structures are up for renegotiation anytime you invest in a new vehicle. As such, it’s important to understand how well the actual real estate performs, as that could potentially result in higher returns for you. It’s also easier to compare across other real estate firms’ vehicles, as the waterfall structures will vary.
Most new institutional investors (such as yourself in this scenario) make a HUGE mistake here. They know that NOI is important, but they fail to specify what kind of NOI they want. Instead, they send an Excel table with column headers for “Property Name” and “NOI”.
As a GP, I’m freaking out! Here’s what runs through my head:
12 Questions to Understand NOI
- Did you mean NOI at acquisition?
- Or NOI at exit?
- Maybe you meant current NOI?
- Or maybe base case underwritten?
- Current projected?
- What about the time frame? Did you mean trailing 12-months?
- Current month (T1) annualized?
- T6 annualized?
- Or projected 12-months?
- If trailing or projected, do I include the current month or start with the month prior or after?
- What GL accounts should be included per their definition of NOI?
- Is that consistent across all of my property types?
Trust me, these questions could go on and on. Most new institutional investors don’t know what they’re looking for, and many a real estate firm throws darts at a dive-bar decades-old dartboard blindfolded and milk-drunk from the fact that they finally landed an institutional investor.
How Real Estate Firms *Should* Present NOI
As a GP, I recommend presenting the version of each metric that shines your firm in the best light, as long as you’re consistent across all investments or properties. Then, leave your investor with a list of footnotes explaining what you did. You’ll want this anyway to document and train someone else to help you someday.
How Investors *Should* Request NOI
As an investor, you’ll want to clarify at least some of the 12 questions above. Otherwise, the data that you receive back won’t be comparable across GPs. And if that’s the case, what’s the point of requesting that data anyway?
What Actually Happens...
Now, let me let you in on a dirty little secret… most institutional investors rarely scrutinize these reports in detail. They will check to make sure that GPs filled them out at least partially. And that’s about it. That said, an investor will – perhaps a new one who read this article – review these reports line by line. They will ask detailed questions and send the report back to the GP, redlined and asking for explanations.
As a GP, you should complete these reports in the same way you do for your regular performance updates; provide just enough information that doesn’t beg additional questions. That may mean filling out all required information, or that may mean filling out what you feel most confident in. I’ll leave that up to you.
Now you know the 12 questions to ask about NOI as a GP and as an institutional investor. I hope you use this knowledge to make improved investment decisions and sharpen your portfolio’s performance. Let me know if you have any questions or edits. I always love hearing from you.
