This is a very common question prospective buyers ask, hence the explanation here. The answer is simple. Are you (buyer) going to pay their mortgage? No! So you want to see the operating expenses. The gross income less operating expenses before any debt service (mortgage) or owner compensation equals NOI (net operating income). And from the NOI you pay YOUR debt service and YOUR owner compensation. Buyers often ask why they don’t see a seller salary on the P&Ls. Well, for the same reason, we remove that because YOU the buyer won’t have to pay the seller salary. So the NOI is the key number when looking at whether a property will cash flow once you subtract your debt service. Then you can pay yourselves from what remains.
Take a look at a sample calculation below based on 20% down at 5%, amortized over 25 years:
Let’s look at 2021. This shows a debt coverage ratio of 1.38. This means that the NOI covers the debt 100% plus has 38% left as cash flow. So that exceeds the bank’s average minimum of 1.2-1.25. Therefore, this is considered financeable. You can see that NOI is key to understand if the purchase can be financed and then you will understand what your potential return or compensation will be based on the year’s performance.
