Net operating income (NOI) is a pivotal metric used to gauge the profitability of income-generating real estate investments. To compute NOI, subtract all reasonably necessary operating expenses from the property’s revenue.
NOI is a pre-tax figure that bypasses principal and interest payments on loans, capital expenditures, depreciation, and amortization. Although primarily used in real estate, NOI is known as EBIT (earnings before interest and taxes) in other industries.
Key Takeaways
- Net operating income reveals the profitability of income properties before factoring in costs related to financing or taxes.
- Calculate NOI by subtracting all operating expenses from total revenue generated by the property.
- Manipulation of income or expense items can affect the NOI metric but does not include capital expenditures.
- NOI helps determine whether renting a property is financially viable for the owner.
Understanding Net Operating Income (NOI)
NOI serves as a valuation tool in the real estate landscape, helping investors determine the worth of income-producing properties. Revenue sources can include rental income, parking fees, and service fees from amenities like laundry and vending machines. On the other hand, operating expenses span costs such as insurance, legal fees, utilities, property taxes, repairs, and maintenance.
Excluding capital expenditures, the NOI metric assists investors in assessing the capitalization rate, thereby aiding in estimating a property’s future resale value. Additionally, it facilitates property comparisons and helps compute the debt coverage ratio, net income multiplier, and ROI.
How to Calculate Net Operating Income (NOI)
The formula for NOI is straightforward. Subtract operating expenses from the revenue generated by the property:
NOI Formula:
Example Calculation:
Revenue
- Rental income: $20,000
- Parking fees: $5,000
- Laundry machines: $1,000
Total Revenue = $26,000
Operating Expenses
- Property management fees: $1,000
- Property taxes: $5,000
- Repairs and maintenance: $3,000
- Insurance: $1,000
Total Operating Expenses = $10,000
Net Operating Income (NOI) = $26,000 - $10,000 = $16,000
Components of NOI
Total Revenue
Total revenue comprises the collective income from your real estate property, factoring in rents, parking, storage fees, vending, and laundry services.
Operating Expenses
Operating expenses cover all costs necessary to run and maintain the property, including taxes, insurance, management fees, utilities, and maintenance repairs.
Net Operating Income vs. Gross Operating Income
NOI differs from Gross Operating Income (GOI), which represents total potential income minus vacancies. NOI, on the other hand, is that GOI reduced by operating expenses.
NOI and Cap Rate
NOI is instrumental in calculating the capitalization rate, a measure of investment property profitability in relation to its cost. Cap rate = NOI / Total Property Cost.
Example of NOI
Imagine owning a property that generates $120,000 in annual revenue but incurs $80,000 in operating expenses. The resulting NOI is $40,000 ($120,000 - $80,000).
Creditors and lenders heavily weigh NOI to evaluate the income potential of a property. This figure aids in assessing the property’s value and suitability for financing.
Manipulating Costs:
Owners can manipulate operating expenses to influence NOI. For example, allowing a tenant to manage the property in lieu of rent could shift costs usually associated with paying a property manager.
Bottom Line
Net Operating Income is a critical metric for real estate investors, helping to evaluate a property’s profitability by focusing on revenue minus operating expenses. Understanding and optimizing NOI can guide better investment decisions and long-term financial planning.
Related Terms: Capitalization Rate, Debt Coverage Ratio, EBIT, Gross Operating Income, Net Income.
