Net Operating (NOI) is a calculation of the income generated by a real estate investment. It measures the amount of cash flow generated by an investment property after operating expenses, but before principal and interest payments, capital expenditures, depreciation, and amortization. Investors use NOI to determine the value and profitability of an income-producing property.
What Is Net Operating Income (NOI)?
In real estate investing, net operating income is the amount of income collected from an investment property after you subtract the operating expenses and vacancy losses. Real estate investors look at a property’s net operating income to determine if the property is a good investment.
They also analyze the NOI of a property that they already own to help determine if they need to raise rents to increase their cash flow. Unlike with cap rate, there isn’t a “good” NOI. Instead, investors can compare the NOIs between properties and use the current NOI to see if their expenses are too high, rents too low, or if the property is unaffordable once they add in their mortgage payment.
Net operating income is generally calculated on an annual basis. So, if you know what your monthly income and expenses are, you just multiply by twelve to get your yearly totals. Keep in mind that NOI should be used in addition to other evaluation tools, such as cap rate, ROI, comparable properties rental income, and cash flow. We recommend using NOI and one of the other tools to best understand the investment property’s overall financial standing.
How Do You Calculate Net Operating Income?
You can calculate net operating income (NOI) for your real estate investment by using the generally accepted net operating income formula, which is your potential rental income plus any additional property-related income minus vacancy losses minus total operating expenses.
Keep in mind that the net operating income formula can vary depending on who’s calculating it.
For example, most investors separate potential rental income and other income, but sometimes you will see them combined. Regardless, the generally accepted net operating income formula is your potential rental income plus any additional property-related income minus vacancy losses minus total operating expenses.
Net Operating Income Formula: NOI = Rental Income + Other Income – Vacancy Losses – Total Operating Expenses
In order to figure out a property’s net operating income, you need to know the potential rental income and other income it produces. You also need to account for vacancy losses from vacant units or units where tenants aren’t paying rent. Lastly, you need to add up all of your operating expenses. Once you have all of those numbers, you can calculate the net operating income of an investment property.
What You Need to Find Your Net Operating Income:
- Potential Rental Income of an Investment Property: Potential rental income (PRI) is the combined total rent under the terms of each individual residential or commercial lease, with the assumption that the property is 100 percent occupied. If the property is not fully occupied, then the amount of PRI is based on a rental market analysis, according to the leases and terms of comparable properties.
- Vacancy Losses on an Investment Property: Vacancy losses represent the loss of income due to tenants vacating the property and/or tenants defaulting on their lease payments. The vacancy factor can be calculated based on current lease expirations. Market-driven figures using comparable property vacancies can also be used for the purpose of calculating a property’s NOI.To calculate vacancy losses, look at what that unit could have rented for and multiply it by however many months out of the year it was vacant. For example, if other similar units rent for $2,000 per month and the vacant unit was empty for three months, you would multiply $2,000 by 3 and get $6,000, which is the yearly vacancy loss for the property.
- Other Income on an Investment Property: Because there are many different ways a property can generate income, real estate investors need to include all possible revenues in their calculation, in addition to monthly rent. These other revenues include, but are not limited to, facility rental proceeds as well as proceeds from vending machines, proceeds from laundry services, income generated from parking fees, billboard/signage fees, and other relevant service charges.
- Total Operating Expenses on an Investment Property: Total operating expenses include all necessary expenditures associated with operating and maintaining an investment property. To get the total operating expenses, you simply add up all of the operating expenses such as property taxes, maintenance, and management fees.Specifically, operating expenses typically include:
Property Taxes: These are assessed by a governing authority in the area the property is located and vary based on location, property value, and size.
Rental Property Insurance: This helps protect your property from loss of income, damage, and perils such as weather-related damage. The average policy on a $200,000 rental property costs $1,473 to $1,596 per year.
Property Management Fees: These fees are charged by a property manager or management company and can vary from 8 percent of gross collected monthly rent for an investment property to over 25 percent of gross rent for a vacation rental property.
Maintenance and Repairs: These include things to keep the property maintained, like pest control, painting, and lawn care, as well as any necessary repairs. Expect to pay about 1 percent of the property value per year on maintenance-related expenses.
Miscellaneous Expenses: These can include things like legal fees, marketing and advertising expenses, and anything else needed to operate the property that doesn’t fall under another category.
Expenses Not Included in NOI
Last but certainly not least, it is important to note that debt service, depreciation, leasing commissions, tenant improvements, repairs to wear and tear, income taxes, and mortgage interest expenses are not included in the calculation of net operating income. This is because NOI is unique to the property itself and does not include other expenses that are specific to the investor/borrower.
