Understanding EBITDA and its Use in Commercial Real Estate

What is EBITDA?

EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. It is a measure of a company's overall financial performance and is used as an alternative to net income in some circumstances. By stripping out these expenses, EBITDA provides a clearer view of a company's operational profitability and cash flow.

How is EBITDA Calculated?

The formula for EBITDA is relatively straightforward:

EBITDA = Net Income + Interest + Taxes + Depreciation + Amortization

This calculation removes the effects of financing and accounting decisions, making it easier to compare the performance of different businesses. In other words, if we take all the income and subtract all the expenses to get the net income, then add back in the "ITDA", we will be able to see how the business is performing on an operational level.

EBITDA as a Multiple in Commercial Real Estate

In the context of commercial real estate, particularly when selling properties like car washes, office buildings, retail centers, or industrial spaces, EBITDA is often used to determine the property's value. Buyers and sellers use an EBITDA multiple to estimate the property's price. The multiple is derived from comparable property sales and market conditions.

For instance, if a commercial property generates an EBITDA of $1 million annually and the typical EBITDA multiple for similar properties in the market is 10x, the property might be valued at $10 million ($1 million x 10).

Comparing EBITDA with NOI in Multifamily Real Estate

What is NOI?

NOI, or Net Operating Income, is another key metric used in real estate, especially in the multifamily sector. It measures the profitability of income-generating properties, excluding financing and tax expenses, making it somewhat similar to EBITDA but with a few distinctions.

NOI is calculated as:

NOI = Gross Operating Income − Operating Expenses

Operating expenses typically include property management fees, maintenance, insurance, and utilities, but not mortgage payments, depreciation, or taxes.

Key Differences Between EBITDA and NOI

1. Scope of Expenses:

   • EBITDA: Excludes interest, taxes, depreciation, and amortization.

   • NOI: Excludes only financing (interest) and taxes but includes property-specific operating expenses.

2. Usage Context:

   • EBITDA: Commonly used in commercial real estate to assess the overall profitability and cash flow of the property, particularly in diverse property types like offices, retail, and industrial properties.

   • NOI: Primarily used in the multifamily space to evaluate the performance of rental properties and other income-generating real estate, focusing on operational efficiency.

3. Valuation Multiples:

   • EBITDA Multiples: Used to value a variety of commercial properties, providing a standardized measure across different types of investments.

   • Capitalization Rate (Cap Rate): Used with NOI to value multifamily properties. The cap rate represents the expected rate of return on an investment property and is calculated as:

     Cap Rate = NOI / Property Value

     Conversely, property value can be determined by dividing NOI by the cap rate. For example, if a property's NOI is $500,000 and the market cap rate is 5%, the property's value would be $10 million ($500,000 / 0.05).

Conclusion

EBITDA and NOI are both crucial metrics in real estate, but they serve different purposes and are used in different contexts. EBITDA provides a broader view of a property's financial performance by excluding interest, taxes, depreciation, and amortization, making it useful for commercial real estate. On the other hand, NOI focuses on the operational profitability of income-generating properties and is predominantly used in the multifamily space.

Understanding these metrics and their appropriate applications can significantly enhance investment decisions, property valuations, and financial analysis in the real estate industry.

On behalf of all of us at GDI Capital Partners, we appreciate you taking the time to further your education and we hope we provided value. Do you have questions about passive investments, underwriting, or anything else real estate related? We’d love to hear from you!