Financial Management and Budgeting
Income, expenses, and NOI
Operating statements follow a simple architecture: rental and other income, less vacancy and concessions, equals effective gross income; less operating expenses equals net operating income (NOI). NOI excludes debt service, capital expenditures, depreciation, and income taxes. Candidates must keep operating expenses separate from capital items - a recurring repair is operating; a roof replacement that extends life is capital.
Budgeting and variance analysis
Budgets are built from rent rolls, market assumptions, historical expenses, and known capital needs. Variance analysis compares actual to budget and explains the gap: is it timing, volume, price, or a one-time event? Good variance narratives say what happened, why, and what will change.
Key ratios and metrics
Know operating expense ratio (operating expenses ÷ effective gross income), cap rate (NOI ÷ value), and cash-on-cash return (cash flow ÷ equity invested). Each answers a different question; mixing them is a classic trap.
Traps to watch for
- Including debt service in NOI.
- Treating a capital improvement as a routine operating expense.
- Comparing properties with different accounting conventions without normalizing.
- Reporting a variance without explanation.
Rule of thumb
NOI is a property-level, debt-free measure. If a payment is to a lender or extends the asset's life, it does not belong in NOI.
Worked example
Effective gross income is $500,000; operating expenses are $200,000. NOI = $300,000. At a 6% cap rate, indicated value = $300,000 ÷ 0.06 = $5,000,000. The operating expense ratio is $200,000 ÷ $500,000 = 40%.