Jansen Multifamily Team Blog

A “bankable NOI” is more than just the net operating income for an investment.  A “bankable NOI” is the net operating income that a lender will place on the asset in order to determine the amount of capital they are willing to lend.  But what constitutes a “bankable NOI” and why is it important?

When determining a “bankable NOI” a lender will require the last 12 months of Profit and Loss (“P&L”) statements for which they will analyze the prior month’s (T-1), the prior 3 month’s (T-3), the prior 6 month’s (T-6), and the prior 12 month’s (T-12) expenses and vacancies to determine the annualized NOI for each (T-1, T-3, T-6, and T-12) period.  The lender will then use the period with the lesser NOI.  For example, if the annualized NOI for the T-3 period is less than the other annualized periods, the lender will use the T-3 annualized NOI as the starting point for determining the “bankable NOI.”

On top of determining the lesser of the above mentioned periods, the lender will place other factors into the expenses regardless of how the current asset is being operated.  One variable includes a vacancy factor.   The vacancy factor is the greater of the perceived submarket vacancy or the current vacancy of the asset.  For example, if the building was completely occupied for the past 12 months, the lender will still use a minimum of 5% as the submarket vacancy factor.  Some submarkets will constitute an even higher vacancy factor.

Another variable used to determine the “bankable NOI” is a management fee.  Most apartment buildings have hired a professional management company to run the day-to-day operations of the investment.  However, some investors enjoy “getting their hands dirty” and decide to manage their assets without incorporating the services of a property management company.  Although these investors are able to increase their overall returns and maintain a greater NOI, a lender will still require a management fee to be incorporated to determine the “bankable NOI.”  For example, even if a building is being managed by the current owner and the owner is not billing himself for management, the lender will not accept anything less than a 5% management fee in his underwriting, and in turn, lowering the “bankable NOI.”

Another variable that affects the “bankable NOI” is replacement reserves.  Replacement reserves are, in essence, “savings” for capital improvements such as a new roof, restriping the parking lot, deck repairs, etc.  Usually, replacement reserves of $250 per unit, although it may go as high as $300 per unit, will be added to determine the “bankable NOI.”

Once the “bankable NOI” is determined, a market capitalization rate will be placed on the “bankable NOI” to determine the purchase price or value of the asset (as discussed in our last post “Investing 101: What are Cap Rates?”).  Once the purchase price or value is determined, the lender is now able to calculate the loan amount for that investment.   Typically, for a 1 million dollar or greater loan most lenders will underwrite to a maximum 75% loan-to-value (“LTV”) and 1.25 debt credit ratio (“DCR”) based on the purchased price or value determined by the “bankable NOI.”

A “bankable NOI” can vary greatly from the actual NOI for any given asset.  Once the lender determines which period to use (T-1, T-3, T-6, or T-12), a submarket vacancy factor, management fee, and replacement reserves will be added in order to determine the “bankable NOI.”  A market cap rate will then be placed on the “bankable NOI” to determine the purchase price or value of the asset which the lender will then use to calculate the amount of loan proceeds to loan on that investment based on the lesser of the LTV or DCR.

Determining a “bankable NOI” is hugely important for investors.  In order for the investor to model out their anticipated year 1 cash-on-cash returns, average cash-on-cash returns, and internal rate of return (IRR), the investor needs to know how much they can obtain in loan proceeds (future posts will discuss cash-on-cash returns and IRR).  The loan amount will directly impact the annual debt service and overall cash flow of the investment.

Without understanding what constitutes a “bankable NOI” and why is it important, an investor will not be able to efficiently and effectively “model” their returns.  The “bankable NOI” will the determine the amount of loan proceeds a lender will loan, in turn, diminishing return expectations for those investors who do not understand and incorporate the “idea” of the “bankable NOI.”