If you own a real estate property or are considering investing in one, the one thing that you certainly want to know is what is the Net Operating Income that it offers, as that is a measure of the return on your investments. Simply put NOI, real estate, is a measure of the income you earn from the property through the year less the operating expenses that you need to incur to keep it operational.
Net Operating Income Formula
Net Operating Income = Gross Operating Income – Operating Expenses
A word of caution here though! In calculating The Gross Operating Income for the year, it is important that you account for potential vacancies during the year. Calculations of Gross Operating Income that are made assuming full capacity can leave you wanting at the end of the year. If you go by the full capacity numbers what you are looking at is Gross Potential Income & not Gross Operating Income. Seen this way:
Gross Operating Income = Gross Potential Income – Potential Losses
If you are calculating this for a property that you are considering to invest in, it will be helpful to research the following:
- Average Vacancy Rates
- Average Rate of Rent Default
Operating Expenses
When it comes to the operating expenses, you need to take into account the following:
- Insurance
- Property Management Fee
- Repairs
- Fee for accountants, lawyers & more
What does not qualify as operating expenses include:
- Income Tax
- Mortgage Payments
- Depreciation
- Capital Expenditure
- Tenant Improvements
An Example Of How To Calculate NOI
Hypothetically, if you are evaluating a potential investment property, which has 5 apartments where the average rental is $2000, your potential income amounts to $120,000 annually. If vacancy losses are estimated at 10%, it amounts to $12,000. The Gross Operating Income therefore amounts to $ 108,000. If operating expenses are estimated to be $15,000 annually,
Net Operating Income = Gross Operating Income – Operating Expenses
NOI in this case equals $108,000- $15,000 =$93000
The Importance of NOI
NOI is extremely useful when it comes to real estate investing since it offers you a good estimate of what kind of income you could stand to make from your property. You will therefore make an informed decision whether or not you should invest in the said property.
Besides being an important metric in ascertaining the potential return on investment of a property, NOI also comes in handy in helping you measure several other aspects of the investment. Some of these include:
Cap Rate
The NOI of a property divided by the purchase price of the property or its asset value offers you the Cap Rate. The Cap Rate thus is a handy metric that allows you to assess the yield of a property over a period of one year.
Debt-Service Coverage Ratio
When you divide the Net Operating Income for the year by the debt owed for the year including both mortgage & interest, what you get is the Debt-Service Coverage Ratio (DSCR). This helps to assess whether or not the net operating income is enough to cover debt obligations.
Net income Multiplier
When you divide the purchase price of the property with the net operating income, what you arrive at is the Net Income Multiplier. This is a reciprocal of the Capitalization rate. The lower this ratio, the better placed you are since it would mean that the net operating income earned by the property represents a higher percentage of the price paid by you in order to acquire the property.
To Sum Up
The answer to what is NOI in real estate, is that it is an essential financial metric to help compare potential investments, as also to calculate the cap rate of a property. In case of an existing, owned property it is important to determine how the NOI is changing over time as that will guide you towards taking the necessary decisions including considering selling the property.
Manage Your Real Estate Portfolio With BFPM
With over 2 decades of property management experience, Beach Front Property Management can help you identify and purchase the right property that offers you a high Net Operating Income with RUBS and therefore is a valuable addition to your portfolio. To know more, get on a quick 15-minute consultation call with us. We’d be happy to guide you.
Trevor Henson
Trevor Henson is an experienced entrepreneur (10+ highly-successful start-ups) and property investor with a demonstrated history of building and leading teams in investment property management environments, maximizing returns for property owners, and optimizing properties through construction management and re-positioning. He…Learn more about how we can help. Customized solutions for large portfolios!