What is net operating income and how does it affect the valuation of properties?
Strong fundamental conditions in the capital market have generally contributed to driving up property prices and especially in the property segments with the most risk-free cash flows - in recent years these have mainly included housing, warehousing / logistics and community properties.
Net operating income is defined as a property's rental income minus its operating and maintenance costs and property tax. To go further into how net operating income affects property valuation, we need to clarify a couple of concepts:
Market value can be considered as the price that would reasonably be paid when selling on an open and free market.
Price depicts an actual result from the market. Before the price is determined, there are several players and conditions that affect the market's or the buyer's willingness to pay, such as expected net operating income and assessed risk.
Yield is a measure of profitability. For directly owned real estate investments, the direct return is derived: Direct return = net operating profit / market value (alternative price).
Yield requirement (yield) can be defined as the requirement for return an investor has on his investment, which is adjusted based on the assessed risk for the specific property. Among other things, existing leases (rent level, length, tenant), geographical location, probable market development and the nature of the property are assessed here.
Learn about more important KPI's in the real estate industry here
Yields and yield requirements can be seen as two different approaches to yields, where yields are the market's assessment of prevailing actual yields and yield requirements as an approach to a rational investor's requirement of what the yield should reasonably be.
Simply put, the market value of a property increases the safer its operating net is judged to be, by the investor accepting a lower required rate of return.
Long leases with the municipality (community properties), housing shortages (housing) and a digitalised and growing retail trade (warehousing / logistics) are examples of segments where investors, through the strong value growth of recent years, demonstrably believe in stable operating nets over time.
Distribution keys
When monitoring net operating income at the property level, there are two different types of costs: direct costs and common costs. Direct costs refer to the costs directly associated with each property, such as media costs. These costs are simply recorded via cost centers.
Common costs are those that are distributed across the portfolio, such as central administration. To get as accurate a picture as possible of how each property is performing, it is important how common costs are allocated. Distribution keys are used for this purpose. Read more about distribution keys here!
Learn about more important KPI's in the real estate industry here
