Net operating income (NOI) is a commonly used figure that investors and lenders use to determine the potential profitability of a property.
When it comes to real estate investing NOI or Net Operating Income is calculated by determining the total revenue of the property minus all the necessary operating expenses. This calculation is used to determine the profitability of income-generating real estate investments.
It’s important to note that NOI is a before-tax calculation that shows cash flow. The calculation excludes non-operating expenses such as the principal and interest on mortgage or loan payments, capital expenditures, depreciation, and amortization. In other industries, this figure is often referred to as the EBIT or earnings before interest and taxes.
Net operating income is an essential figure for several different essential real estate metrics and it’s important to understand exactly what it is and how it can be used to determine the current value and potential of an investment property. To calculate NOI, you need to subtract the property’s operating expenses from the total income that the property produces.
Operating expenses include things like ongoing maintenance and operation fees such as property management fees, insurance premiums, legal expenses, or HOA fees. Capital expenditures are not included as they need to be added to the property’s cost basis and depreciated and are not immediately deductible.
In addition to rental income, a property might also produce several other streams of income that need to be included. For example, a property might generate additional revenue from parking, laundry facilities, or vending machines.
NOI can be used to help determine cap rate (capitalization rate), debt coverage ratio (DCR), net income multiplier, and return on investment (ROI). These metrics can help investors understand a property’s value and current performance as well as the potential profitability of a future investment.
Net operating income is thankfully relatively easy to calculate. As already mentioned all you need to do is to calculate the total income the property generates and subtract the total operating expenses.
Revenue from real estate includes
Operating expenses include all of the ongoing and regular costs associated with operating the property. These include:
Net Operating Income (NOI) = Total Income – Total Operating Expenses
Things that are not included in the calculation of the total operating expenses include:
In this example, we are going to assume the following information as the profile of a particular investment property.
Annual Income Sources:
Total Annual Income = $26,000
Annual Operating Expenses:
Total Annual Operating Expenses = $10,000
The net operating income (NOI) in this example would be $26,000 – $10,000 = $16,000.
If the total is negative, where operating expenses are higher than revenues, the result is called a net operating loss (NOL).
Net operating income is one of the most commonly used figures that investors and lenders use to determine the potential profitability of a property. For creditors, they rely on this calculation heavily to determine the income generation potential to ensure when assessing the security of a loan, and they often look at this figure more closely than the credit history of the investor.
If a property is deemed by lenders to be a good and profitable investment, the lenders will also use this figure to determine the amount of the loan they’re willing to make. On the other hand, if the property shows a net operating loss, lenders are likely to reject the borrower’s mortgage application, outright.
Property owners can manipulate their operating expenses by deferring certain expenses while accelerating others. NOI can also be increased by raising rents and other fees, while simultaneously decreasing reasonably necessary operating expenses.
This is one of the reasons it’s absolutely essential for investors to keep accurate and detailed financial records with a system like Landlord Studio for all their investments. This data will inform future potential income and expenses as well as provide lenders with clear historical proof of an investor’s ability to achieve a positive NOI.