What is Net Operating Income and Cash Flow?

Toward the bottom of the Pro-Forma are important metrics for valuing the property and determining its performance in a deal.

Net Operating Income (NOI) is Effective Gross Income – Operating Expenses & Property Taxes.

This item is similar to EBITDA for normal companies – a capital structure-neutral measure of core-business cash flow – but it’s not the same.

For example, if you deduct the Reserve Allocations, as we do, then NOI partially reflects capital costs.

EBITDA, by contrast, never reflects capital costs because it excludes CapEx and D&A.

NOI is critical because properties are often valued based on their projected NOI divided by a selected “Capitalization Rate” (Cap Rate) or “Yield.”

For example, if a property’s projected NOI is $5 million and Cap Rates for similar properties in the area are 5%, this property might be worth $5 million / 5% = $100 million.

If your NOI figures are off, then your valuation will be off as well.

Adjusted NOI is NOI – Net Capital Costs; it’s similar to Unlevered FCF for normal companies since it’s core-business cash flow after capital costs, ignoring capital structure.

But it’s not quite the same as Unlevered FCF because Adjusted NOI excludes income taxes, the Change in Working Capital, and several other items that go into Unlevered FCF.

Even if you disagree with our treatment of the Reserves in NOI, you’d still have to deduct the Reserve Allocations in this section – so Adjusted NOI ends up being the same.

Cash Flow to Equity is Adjusted NOI – Debt Service; it’s fairly close to the equity investor distributions a property can make each year.

The main items in “Debt Service” are Cash Interest paid on Debt and Principal Repayments. You might calculate these with the IPMT or PPMT functions in Excel, or you could do it manually, depending on the terms.

Nearly all property acquisitions and developments are funded partially by Debt, so you will almost always see the Interest Expense on that Debt on the pro-forma.

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