Self Help

In real estate, net operating income is defined as annual gross potential rental income from a property less vacancy and collection losses, operating expenses, replacement reserves, property taxes, and property and liability insurance. Here’s a list of what may show up on a net income statement:

1. Gross annual potential rents. This amount is the largest possible sum of rents that you could theoretically bring in at current market rent levels and 100 percent occupancy.

2. Income from parking and storage areas. For example, a property may have a sixteen-car parking lot. Due to an extreme shortage of on-street and off-street parking in the neighborhood, you could rents out the parking spaces separate from the apartment units. Also, you can build storage bins in the basement of the building that are available for rental to tenants.

3. Vacancy and collection losses. Market vacancy rates in any given area typically range between 5 and 10 percent. Even the best managed apartments experience some vacancies when apartments turn over. As a practical matter, you should figure some losses for tenants who move out owing rents that exceed the amounts of their security deposits.

4. Effective gross income. This term refers to the actual amount of cash that an owner receives net of vacancy and collection, but before operating and fixed expenses.

5. Utilities. Sometimes tenants may pay all of their own utilities, but as the property owner, you will pay for lighting in the hallways, basement, and parking area.

6. Licenses and permit fees. Apartment building owners sometimes must pay business licenses or other fees.

7. Advertising and promotion. These units generally rent by word of mouth or a “For Rent” sign that’s posted on the property. However, as a precaution, an advertising and promotion expense per year per unit may be allocated to the operating budget.

8. Management fees. These fees pay for anyone that you may hire to run the property. But many times the owner manages the property. Nevertheless, he should pay himself the same amount he would otherwise have to pay a property management firm. Returns for labor should be kept separate from returns on investment.

9. Maintenance and repairs. The owners typically clean, paint, and make small repairs. These labors, too, deserve payment from the property’s rent collections.

10. Miscellaneous. This expense covers legal fees, supplies, snow removal from the parking lot, municipal assessments, auto mileage to and from the property, and other items not accounted for elsewhere in the income statement.