What Is Net Operating Income In Real Estate?

Key Takeaways

  • To determine the net operating income of an investment, subtract operating expenses from the total income a property generates.
  • Understanding NOI will help investors with a number of other real estate calculations, such as calculating the cap rate of a property.
  • A property’s NOI factors in a lot of variables, which begs the question: Does NOI include mortgage?

No matter where you are in your career as a real estate investor, you stand to benefit from understanding how to evaluate the profitability of investment opportunities. Net operating income (NOI) is one of several indicators investors can use to determine whether or not a given property will make a good investment. By measuring the ongoing operating costs of a property, real estate investors can use NOI to analyze how much money can potentially be generated from a given deal.

When calculated correctly, NOI can serve as a valuable standard when comparing potential deals, or even evaluating an existing property. Keep reading to learn how a net operating income real estate analysis can help you measure a deal’s potential.

Understanding NOI In Real Estate

What is NOI real estate? Net operating income is one of several metrics used by investors to determine how profitable a property is. Most frequently, net operating income is a benchmark used by investors to determine the amount of cash flow and profitability of a potential deal or income-generating property. NOI is a strong indicator of a property’s ongoing revenue, though it does not account for capital expenditures, taxes or interest payments. Instead, NOI is used to determine how profitable a property is on its own.

By using NOI to evaluate a deal, real estate investors can get a better look at the potential profitability of a property in relation to how much it would cost to operate it. NOI is typically calculated on an annual basis; although, investors can easily adapt the operating costs by multiplying monthly expenses by twelve. By excluding financial factors such as mortgage interest and taxes, NOI provides a specific look at the income a property can generate on its own. Because of this, NOI is thought to be less subject to manipulation when compared to other real estate calculations.

The only challenge in predicting NOI is that the potential income will depend entirely on the way the property is being operated. Investors should be careful to use market factors as a reference when estimating potential rental income.


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NOI for real estate

How To Calculate NOI

NOI for real estate is calculated by using the total income generated from a property and subtracting the operating expenses. Start by adding up rental income and any other revenue generating items on the prospective property. This can include fees for parking, laundry and vending machines and any service fees.

Next, add together the operating costs of the subject property. Operating costs refer to any costs associated with running and maintaining the property on a given basis. These will include insurance costs, utilities, property management fees, property taxes and repair costs. The formula will look like this:

Income Generated From Property – Operating Expenses = NOI

As an example, if the total income of a property was $10,000 and operating expenses averaged around $4,000, the net operating income would be at $6,000. If, on the other hand, the total income was at $4,000 and the operating expenses were at $10,000, the NOI would instead be -$6,000. In cases such as this, with expenses totalling more than the income generated, it would be called a net operating loss (NOL).

What Expenses Are Included In NOI?

The key to understanding the NOI real estate term is knowing which expenses are included and which are not. As a general rule, operating expenses should refer to any day-to-day costs associated with running the property. The following is a list of examples:

  • Property management fees
  • General maintenance
  • Groundskeeping
  • Legal fees
  • Utilities costs not paid by tenants
  • Property taxes
  • Insurance costs

What Expenses Are Not Included In NOI?

When determining the net operating income, it is important to differentiate between costs that are unique to the property itself and costs that are specific to the investor. For example, when it comes to NOI, mortgage interest expenses will not be factored in. Here are other factors that would not be included when calculating net operating income:

  • Mortgage interest
  • Income taxes
  • Debt service
  • Property depreciation
  • Tenant improvements
  • Repair for wear and tear

NOI real estate term

When To Use NOI In Real Estate

Net operating income is primarily used when determining profitability for commercial or residential rental property real estate investments. When considering potential deals, NOI can be utilized by both investors and lenders. By looking at this indicator, lenders can judge whether or not investors will make enough cash flow to make loan payments. It is not uncommon for NOI to be used when approving commercial loans for real estate investors. This is because lenders want to know whether or not investors will be able pay back the loan when considering the potential cash flow.

While NOI is thought to be a reliable indicator when determining the potential income of a property, it is not the only real estate calculation investors should keep handy. Investors should familiarize themselves with a number of formulas in order to analyze deals effectively.

Additionally, NOI can be used as a variable in other calculations designed to evaluate investments. When determining the capitalization rate of a property, investors will need to use the net operating income and the property value in order to determine the potential rate of return.

Summary

The right real estate calculations can provide investors with the ability to evaluate properties and make informed investment decisions. Now that you can answer the question “what is net operating income in real estate?”, you should be more prepared to use the metric as you analyze deals. Remember, net operating income (NOI) can serve as a basis for evaluating potential properties, and can even be used in conjunction with other real estate calculations to help further analyze deals. By understanding NOI, investors will be better equipped to estimate the income of their potential deal and have success in real estate.

Do you have a better idea on what is NOI in real estate? Share your thoughts in the comments below.

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