What is Net Operating Income?

What is Net Operating Income?

Real estate professionals calculate net operating income, or NOI, to determine the value of their income properties and the potential it has for generating profits.

This helps real estate investors determine a property’s value and income-generating abilities which helps them decide whether or not they should purchase the property. 

How Is NOI Calculated?

Calculating a property’s net operating income is an extremely simple, straightforward process. You can easily find this number by using the following equation:

NOI = Gross Real Estate Income - Operating Expenses

The biggest challenge in calculating this number is to add up all of the operating expenses. Typical operating expenses can include: 

• Property Management Fees

• Maintenance Fees

• Property Taxes

• Legal Fees

• Insurance

• Utilities not paid by a tenant

Your NOI does not include your mortgage payments, depreciation, or amortization since your mortgage is not an operating expense.

If you were calculating the property’s cash flow or gross operating income, you would factor the mortgage into the equation.  

Why Is NOI Important?

Real estate investors use NOI to help them calculate some other figures related to the property and their business.

The NOI is especially important when it comes to considering business planning, market value, and financing considerations. Lenders will look at the NOI when determining whether or not to finance a property - especially in transactions involving multifamily, syndicates, and/or large real estate portfolios.

They want to make sure the NOI will cover the mortgage after all operating expenses are paid. 

How To Improve NOI

Once you have calculated the NOI of a property, you may be rethinking purchasing the property since it does not appear to generate enough income.

The good news is, while there are many areas in real estate investing that are out of your control, you do have control over your NOI to some degree. 

If you need to improve your NOI, the easiest way to do so would be to reduce operating expenses.

Maybe you can find a less expensive property manager to save a few dollars. Are your maintenance fees too high? See how they can be reduced in order to save some money and raise your NOI. 

Another way to improve NOI is to increase the overall income of the real estate. This is a bit more challenging since it is based largely on market conditions and not entirely in your control.

Could you raise your monthly rental rate without causing tenants to move out or become delinquent on their payments? If so, it may be worth considering. 

Additionally, are there value-added services or products you can add to increase the property's income-producing ability?

Things like on-site laundry, food and drink vending machines, parking fees, and others can help increase income without causing too much friction with tenants.

The Bottom Line

If you are a real estate investor, you need to know how to calculate the NOI.

NOI = Gross Real Estate Income - Operating Expenses

Additionally, you'll need to be familiar with how to manipulate this number to translate into an improved NOI. Some ways to do this include increasing your real estate's revenue and to lower operational expenses.

To be successful, you will need to find a way to reduce operating expenses since income can tend to have limitations. All in all, being able to calculate NOI is a valuable resource if you're investing in real estate.

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