Net Operating Income (NOI) is a crucial metric in real estate investing. It represents the profitability of an income-generating property before accounting for financing costs (like mortgage payments) and income taxes. In essence, it tells you how much money the property itself is producing, regardless of how it was purchased.
Why is NOI Important?
Property Valuation: NOI is the primary factor used in the income capitalization approach to property valuation. Investors often use the capitalization rate (Cap Rate) to estimate a property's value based on its NOI.
Investment Comparison: NOI allows investors to compare the potential profitability of different properties on an apples-to-apples basis, irrespective of their financing structures.
Performance Measurement: It helps track the operational performance of a property over time, identifying trends in income and expenses.
Lender Assessment: Lenders use NOI to determine a property's ability to service debt.
Calculating NOI: The Formula
The calculation is straightforward:
NOI = Gross Operating Income – Total Operating Expenses
Gross Operating Income (GOI): This is the total potential income from the property, including rental income and any other revenue streams (like parking fees, laundry facilities, etc.), minus any allowances for vacancy and credit losses.
Total Operating Expenses: These are all the costs associated with running and maintaining the property on an annual basis. Crucially, operating expenses do not include:
Mortgage principal and interest payments
Depreciation
Capital expenditures (major improvements like a new roof or HVAC system, though regular repairs are included)
Income taxes
Owner's personal expenses
Common Operating Expenses Include:
Property Taxes
Property Insurance
Property Management Fees
Repairs and Maintenance
Utilities (if paid by the owner)
Salaries for on-site staff (if applicable)
Advertising/Marketing
Legal and Accounting Fees
HOA fees (if applicable)
Example Calculation:
Let's consider a small apartment building:
Annual Rental Income: $50,000
Annual Other Income (Laundry): $2,000
Annual Property Taxes: $6,000
Annual Property Insurance: $2,500
Annual Property Management Fees: $5,000
Annual Repairs & Maintenance: $3,000
Annual Utilities (paid by owner): $1,500
Annual Vacancy Loss Allowance: $2,500
Other Annual Operating Expenses (e.g., supplies): $500
Step 1: Calculate Gross Operating Income (GOI)
GOI = (Annual Rental Income + Annual Other Income) – Annual Vacancy Loss Allowance
In this example, the Net Operating Income for the apartment building is $31,000 per year. This figure is what an investor would use to assess the property's performance and potential returns.