Net Operating Income
Net Operating Income (NOI) is a key profitability metric used in the real estate industry to evaluate the income-generating potential of a property. It is calculated by subtracting all operating expenses from the property’s gross operating income.
Operating income refers to the revenue that the property generates, which can include rental income, income from vending machines, parking fees, and other income generated by the property.
Operating expenses include costs necessary to operate and maintain the property, such as property management fees, repairs, maintenance, utilities, property taxes, and insurance. However, it does not include mortgage payments, depreciation, or income taxes as these are not considered operating expenses.
The formula to calculate NOI is:
Net Operating Income = Gross Operating Income – Operating Expenses
NOI is a pre-tax figure that excludes principal and interest payments on loans, capital expenditures, depreciation, and amortization. This metric is particularly useful because it allows real estate investors to evaluate the profitability of a property independently of various financing strategies and tax implications. It’s essentially a measure of the property’s potential income if it were bought outright without a loan.
For example, if a property generates $100,000 in annual rental income and has operating expenses of $40,000, its NOI would be $60,000 ($100,000 – $40,000).
NOI is also used in the calculation of other key real estate metrics, such as the capitalization rate (or “cap rate”), which is calculated by dividing NOI by the property’s market value. This allows investors to compare the profitability of different properties regardless of their purchase price.
Example of Net Operating Income
Let’s assume you own a small apartment building as an investment. Here are the details of the building’s income and expenses for the past year:
Gross Rental Income: $200,000 Laundry/Vending Machine Income: $5,000
Operating Expenses:
- Property Management Fees: $10,000
- Repairs and Maintenance: $15,000
- Property Insurance: $5,000
- Property Taxes: $20,000
- Utilities (Water, Electricity, Trash): $10,000
First, let’s calculate the Gross Operating Income. This is simply the total income the property generates:
Gross Operating Income = Gross Rental Income + Laundry/Vending Machine Income
Gross Operating Income = $200,000 + $5,000 = $205,000
Next, sum up the Operating Expenses:
Total Operating Expenses = Property Management Fees + Repairs and Maintenance + Property Insurance + Property Taxes + Utilities Total Operating Expenses = $10,000 + $15,000 + $5,000 + $20,000 + $10,000 = $60,000
Finally, calculate the Net Operating Income (NOI) by subtracting the Total Operating Expenses from the Gross Operating Income:
Net Operating Income = Gross Operating Income – Total Operating Expenses
Net Operating Income = $205,000 – $60,000 = $145,000
So, the apartment building generated a Net Operating Income of $145,000 over the past year. This is the income that the building generated after considering all operating expenses, but before considering costs like mortgage payments, depreciation, or income taxes.
