Net Operating Income Indicates Value, but Know Your Property’s Zoning

02/03/2016 1:11 am

Skytower Brisbane

This post was prepared by Sara Player, Blockbrief In-house Counsel

Net Operating Income

Net Operating Income (NOI) is used to analyze real estate investments that produce income.  It is the annual income generated by an income-producing property after taking into account all income collected from operations, and deducting expenses incurred from operations.  It’s solely unique to the property, rather than the investor, as it does not take taxes or financing costs into account.

 

NOI Calculation

Potential Rental Income- Vacancy and Credit Losses = Effective Rental Income

Effective Rental Income + Other Income = Gross Operating Income

Gross Operating Income- Operating Expenses= Net Operating Income

 

 

Zoning Laws Impact on Property Value

While NOI is a good indicator of value for commercial real estate, a smart investor will always be aware of current and prospective zoning laws of the property and surrounding properties.  Zoning laws specify the type of dwelling that can reside in a specific area.  The three general zoning categories are residential, commercial, and industrial.

Zoning directly impacts the value of your land and the zoning that will give your land the most value depends on the market demand in that specific area.  In fact, astute real estate developers and brokers will work to increase their property value by obtaining a change in the zoning law for that property that better matches market demand.  For example, a residential zoning will be more valuable than commercial for a property located in an area with few residential zoned buildings where there is a high interest in living.  Whereas, a change to residential zoning from industrial zoning can actually lower your property’s value if it’s located in a primarily industrial area where there is very little to no demand by residential renters.

To go one step further, within these general categories different limitations will be set on a property; such as the amount of units a building is permitted to have.  For example, one commercial property may be permitted to have more commercial floor space than another, (e.g. 500 m2 versus 1,000 m2), it directly impacts a commercial property’s potential operating income.

Buyers should also be aware of the zoning permits and restrictions, as well as potential zoning changes, in the surrounding area as the zoning of one property can impact the value of other nearby properties. NOI is directly impacted by the amount of rent an owner can collect and rent rates are largely impacted by supply and demand.  If there are many commercial spaces available in the area and there is more supply than demand, then rent may decrease.  If there are few spaces available and high demand, rent prices will likely be higher.   Consequently, if a property is rezoned to permit more floor space in that commercial building and the developer acts upon that rezoning, it will increase the availability of commercial floor space in that market.  As a result, it can impact the surrounding property’s value even though their zoning laws were not directly affected.  This is a potential impact that buyers should be aware of as it will not be apparent by just looking at the current NOI of a commercial building.

The resources and tools made available by Blockbrief make it easy for to understand the zoning laws of any property and the implications.  Learn more here.