Net operating income (NOI) is a term often used in real estate accounting that refers to the formula for the profitability of a commercial property. In other words, the formula shows the cash flow a property has after subtracting all reasonable expenses. As a brief example of this, if a business owner is experiencing growth and makes the decision to expand into a larger location. To calculate the net operating income they would take the gross income of the business and subtract the corresponding expenses; property fees, insurance, building upkeep, and utilities. Specifically, This would include anything necessary to keep the property functioning as usual. You wouldn’t include the payment of the new company vehicle, even though it is a business expense it is not tied directly to the building. Gross income refers to all of the income generated by the property minus the cost of goods sold. In easier terms, if you have a basic rental property, like a 4 plex, the gross income would be the complete rent amount minus the cost of any empty units. This will get more complicated depending on if there are parking fees, onsite laundry, etc. that would add to the income of the property. Operating expenses are only the expenses needed to operate the property. Some examples of common operating expenses are property taxes, insurance on the property, and maintenance utilities not paid by tenants. A few common expenses that are not included in operating expenses are income taxes, property depreciation or any fees that occurred through financing. If you are questioning whether or not an income or expense should be included, remember to ask yourself if it fits the criteria of being necessary to operate the property and charge the market rate. You are considering purchasing one of two properties. You will want to calculate the net operating income of each property to determine which will be the best investment.Net Operating Income Formula
Net Operating Income Example
First, Property A has a rental income of$75,000 and a parking income of$20,000. Their property taxes would be$15,000 andtheir property management fees are$7,000. Finally, their maintenance and repairs would be$30,000, while their insurance costs are$4,000. The total operating expenses are $56,000.
Second, Property B has a rental income of$150,000, and propertytaxes of$45,000. Their property management fees are$15,000 while maintenance repairs come to$25,000. Finally, their insurance is $7,000 while utilities are$35,000. The total operating expenses are $127,000.
Let’s break it down to identify the meaning and value of the different variables in this problem.
Property A
- Gross income: $95,000
- Operating expenses: $56,000
Property B
- Gross income: $150,000
- Operating expenses: $127,000
Let’s apply the values to our variables and calculate net operating income for Property A:
In this case, the net operating income would be $39,000.
Now let’s apply the values to our variables and calculate net operating income for property #2:
In this case, the net operating income for Property #2 would be $23,000.
Now you can easily see that Property #1 has a better return. This means that, each year, this property will out-earn property #2 by $16,000. If you’re looking for a property that would provide you with the best return on your investment, this would be the better option.
Net Operating Income Analysis
Using Net operating income, you can make critical real estate decisions with relative ease. In the above example, it was about purchasing a new property to determine which would be the best investment by providing you with the highest potential income.
Net operating income will also allow a company to assess the current financial health of the properties currently owned. This may be helpful to determine how you can better improve the cash flows of business assets or which property would be the best to sell.
When looking at the results of calculating the net operating income of a property there are only two ways to interpret the data, it’s either good or bad. Anything positive is good. Likewise, anything zero or negative is bad.
If by chance you do calculate net operating income for a property you own and the result is negative there are a few options you have to turn it into a positive. The first would be to increase the amount of income that the property generates. Are you actually charging the market rate? If it is an apartment complex can you charge for parking passes or add an on-site laundromat?
If increasing your income is not a viable option, think about how can you decrease the operating expenses for the property. Perhaps you can get a better insurance rate? Can the tenants pay for their own utilities? Look for anything that you can decrease in terms of your operating expenses. If there is nothing that you can do then it might be time to consider liquidating the property.
However, it’s important to remember that this number won’t tell you everything you need to know about an investment. There could be other factors that might affect your final take-home amount. As a result, it’s important to consider this in your full portfolio.
Net Operating Income Conclusion
- The net operating income is a metric to show the current financial health of a property or the potential profitability of a real estate property.
- The formula for net operating income requires two variables: Gross income and Operating expenses.
- When calculating net operating income, donot include income tax.
- The net operating income formula should be used to make real estate decisions.
Net Operating Income Calculator
You can use the net operating income calculator below to quickly calculate the profit potential of a property by entering the required numbers.
FAQs
1. What is Net Operating Income (NOI)?
Net operating income is a metric that is used to show the financial health of a property or the potential profitability of a real estate investment. It measures the amount of cash flow that a property generates after all expenses are paid. In other words, the formula shows the cash flow a property has after subtracting all reasonable expenses.
2. What is the formula for calculating Net Operating Income (NOI)?
The formula for calculating net operating income is:
Net Operating Income = Gross Income - Operating Expenses
3. What is the difference between the Net Operating Income (NOI) and net income?
The main difference between net operating income and net income is that net operating income does not include the impact of income tax. Net income takes into account all sources of revenue and subtracts all relevant expenses, including taxes.
4. What is a good Net Operating Income (NOI) percentage?
For most business entities, a net operating income percentage of 20% or more is considered good. However, this number can vary depending on the industry and other factors.
For example, a net operating income percentage of 30% or more would be considered excellent for retail property. But a net operating income percentage of 10% or less may be considered good for a long-term care facility. This is because the expenses for a long-term care facility are typically higher than those for retail property.
5. Are Net Operating Income (NOI) and EBITDA the same?
No, net operating income and EBITDA are not the same. Net operating income measures the cash flow generated by a property after all expenses are paid. EBITDA stands for earnings before interest, taxes, depreciation, and amortization. This metric measures the pre-tax profit of a company.
