In trying to build a REIT information base for Singaporeans who are wondering how to invest money in Singapore as a beginner, we can’t run away from the all important net operating margin.
Net Operating Income is the amount of income that can be generated from the property after the deduction of operating expenses. Hence it can be summarised as:
Net Operating Income = Gross Income – Operating Expenses.
Net Operating Margin will hence be the Net Operating Income (commonly known as NOI). It is a reflection of how efficient the REIT is. For example if REIT A has a lower Net Operating Margin than REIT B, it can either be a reflection of less cost conscious management or an entirely different cost structure. This is an important point to note as we should always try to compare apples with apples.
Gross Income generally comes from rental income from the tenants who are staying in the company. It can also include things such as car park fees and other types of fees income. However rental income is generally the biggest component.
Depending on the market that you are in, rental income can be computed differently. There are some landlords or property managers who charge a fixed monthly rate. There are others who charge a lower fixed rate but would like a variable component as a % of their tenants sales. This type of setup is usually more common in retail.
Even in market upswings, net operating margins can be slow to increase. This is because revenue growth in terms of rental reversion is often quite slow. This is because retail contracts generally last 2-3 years. In a market upswing, some of the contracts that were previously negotiated in a market lull will still be in effect. Hence the rental reversion will not come into effect for all the rental contracts.
However, rental contract negotiation is not the only reason why net operating margins can be slow to react. As Net Operating Margins is ‘Net’, cost is the second part of the equation. For a business, cost can be very sticky. For example, it is often easier to hire an employee than it is to fire him or her.
Generally speaking, the higher the net operating margins is the better the business. However, there are also other things to take note of including capital management and management expertise.