Q: I just ran a quick calculation related to a business completing an energy efficiency upgrade paid in cash that created a permanent savings of $1,000 per month on utilities. I employed the 0.077316 Debt Constant we used in the webinar. Am I correct in concluding that this $12,000 annual increase in NOI would result in additional annual debt support of $155,844.16 per year?
A: You're applying the concept exactly right. If the NOI available to service interest-bearing debt on an income producing property increases by $12,000 when the debt constant is 0.077316, the $12,000 of additional NOI will support $155,207 of additional term debt – or (($12,000) / (0.077316)) = $155,207.
If the lender applies a DSC minimum such as 1.15, the NOI available to service interest-bearing debt will be less, i.e., (($12,000) / (1.15)) = $10,435. Additional NOI of $10,435 will support $134,966 of additional term debt rather than $155,207.
As we concluded in today’s session, our best estimate of NOI was $274,655. With a DSC minimum of 1.15, the amount of NOI available to service interest-bearing debt becomes $238,830, and $238,830 of NOI will support $3,089,011 of term debt, given a debt service constant of 0.077316. If NOI now increases by $12,000 to $286,655, available NOI at a DSC of 1.15 falls to $249,265. $249,265 of NOI can support (($249,265) / (0.077316)) = $3,223,977 – a $134,966 increase, which precisely matches the increase computed in the paragraph above.
Note that the amount of additional term debt that can be supported by any increase in NOI – either from an increase in rental revenue or a decrease in operating expenses – depends on the financing terms and the resulting debt service constant.
Course overview: Underwriting Standards, Actual vs. Stabilized NOI, and Breakeven Analysis