The Net Operating Income (NOI) is one of the most essential calculations in real estate. It serves as the basis of many big financial decisions and calculations. If you’re involved in the industry, you need to know this staple. Let’s break down each aspect of how NOI in real estate works below, step by step.
Main Takeaways:
The Net Operating Income is a formula that predicts a property’s future profits, financial risk, and market value.- The net operating income formula is “gross operating income – operating expenses = net operating income.”
- The gross operating income is your property’s overall income, minus vacancy rates and certain other fees.
- Operating expenses are any expenses crucial to maintaining a property’s basic financial and physical stability (not upgrading it).
- The Net Operating Income impacts other calculations, like your property value and cap rate.
What is NOI in Real Estate?
To sum up how a Net Operating Income formula works, its purpose is to estimate your investment’s financial forecast. It bundles together a basic snapshot of your property’s projected profits, possible financial risk, and viable market value.
It lets you subtract expected operating costs and vacancy losses from the gross rental income to help determine a property’s ultimate revenue and profitability. In other words, you filter out some (but not all) 
core profit-deducting factors to get a rough estimate of your ROI. As property managers in Northern Virginia, we know how critical it is to crunch these numbers before getting involved with properties.
Net Operating Income Formula: Net Operating Income = Gross Operating Income – Operating Expenses
What is Gross Operating Income?
Your property’s anticipated overall income per year. In addition to rent, this also consists of all secondary streams of income your property provides, such as a mini-mart or laundry services.
When calculating your gross operating income, remember the factors that can cut into it. For instance, be sure to subtract any added expenses that income might bring, like credit card usage fees.
Also, you should factor in areas where you’re putting in more money than you’re getting in return. These include vacancy rates or maintained units that tenants aren’t sufficiently paid for.
Another factor that affects your income could be credits you provide to others, like credits for paying on time.
To frame this in another way, when calculating your gross operating income, think about this formula:
Gross Operating Income Formula: total income from all property income streams – any income detractors = gross operating income.
What Counts as Operating Expenses Here?
Operating expenses can be defined as any expenses that are fundamental to keeping an investment in financial and physical shape.
Some examples include repair fees, maintenance fees, admin fees, utility fees, housekeeping, insurance, and countless other hidden costs you must account for.
However, expenses that go towards improving, not just maintaining, your property’s value wouldn’t count. E.g., interest and purely aesthetic renovations aren’t operating expenses. In a similar vein, capital expenditures don’t count, in general.
Operating Expenses Formula: Operating expenses = routine, expected expenses that you must pay to maintain your property’s financial and physical stability
Gross Operating Income vs. Net Income
As similar as they sound, your gross operating income and net operating income are two different concepts.
The gross operating income refers to how much money you plan to earn from your property. It’s just one component of finding out the broader income sum, your net income.
Meanwhile, your net operating income is the gross income you think you’ll end up with at the end of the day after you detract your operating expenses.
About Net Operating Losses
Unfortunately, if you find your NOI has a negative number, that means your investment could be in the red. This is called a net operating loss.
If you are planning a prospective investment, you may want to scrap your plans. Otherwise, if your current investment has poor projections, you should investigate new angles to cut costs and bring in profits. As one example, you could try to tactfully raise the rent.
In the end, your goal is to invest a fair bit less than you gain in return.
How to Apply Net Operating Income Calculations in Your Business
With a net operating income calculation, you can get a feel for whether an investment’s profit margins are big enough to pursue. You can uncover if you’d end up burning more money investing than you’d receive in returns.
Or, if you already have an existing investment, you can test your investment’s future financial health. You can check if you’re setting it up for success or need to make operational cuts or additions.
Cap Rate: One of the most common ways people use net operating income calculations is to find their cap rate. In summary, the cap rate represents your total potential ROI rate. When it comes to this, there is a certain cap rate range you should strive towards.
Property Value: In turn, the cap rate and net operation income combined make up a property’s value. This can help you create a selling or rental rate.
Debt Service Coverage Ratio: You and your lender can use the net operating income to compute if your investment’s payout would be enough to pay relevant loans. This calculation is also known as the debt service coverage ratio.
Cash-on-Cash Returns: Next, you can use a net operating income to analyze your cash-on-cash returns, which will show you the pre-tax difference between your cash invested versus your cash earned.
All in all, the higher your net operating income is, the better your business’s profit potential and overall outlook are.
Other Factors to Consider
Of course, the net operating income doesn’t show the entire story in one fell swoop. There are other elements you should factor in when determining a property’s profit potential. Most significantly, you should not add these elements to your net operating income calculation itself – consider them in addition to your NOI.
These include, but aren’t limited to:
- Long-term property deterioration
- Capital expenditures
- Optional property upgrades
- Loan interest, amortization, and down payment
- Taxes
These shouldn’t be included in the net operating income because they are too much of a wild card. They can look drastically different for each investor, property, and even property unit. For example, single-family homes and multi-family homes have vastly different tax implications.
Maximize Your ROI with PPM
You can use the Net Operating Income to predict a property’s future profits, financial risk, and market value. What’s more, this tool can serve other purposes, too. It can allow you to find your cap rate, property value, and other priceless information.
Raising your property value necessitates constant upkeep, problem-solving, and innovation. You cannot let anything slip through the cracks—there is little room for error.
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