One of the most popular questions about investment properties have to do with methods on knowing if a deal is going to potentially be profitable…
The answer is always MATH!
Math should be the foundation on all transactions NOT emotions!
The most popular formulas that we use to find out if a property can POTENTIALLY be profitable is calculating the Net Operating Income (NOI) :
NOI = Effective Gross Income (EGI) - Operating Expenses
To find the EGI you will use the total amount of real income collected the last 12 months in the property
The operating expenses include the total amount of ongoing expenses you will incur from day-to-day operations on the property… EXCLUDING your debt payments and one-off expenses.
So for example, if your property’s EGI is $2,000,000… and your Operating Expenses add up to $1,000,000…
Then your NOI for the year is $2,000,000 - $1,000,000 = $1,000,000.
This is probably the second most important number when evaluating a deal, because:
1) You can actually see HOW profitable your property could be each year… In other words, how much income it could bring you annually before taxes.
3) You need this number to calculate the Cap Rate, which in turn determines the property’s rate of return and VALUE.
4) You need to know what your NOI is at 100%, 90%, 85% occupancy – to see if your deal cash-flows enough to weather the absolute worst case scenarios you can think of.
5) If you can increase the NOI, you could increase the price the next investor pays for your property… and potentially INCREASE your profit when you exit the deal.