What Is Net Operating Income? NOI in Real Estate Explained

Net operating income, or NOI, refers to net income or potential income you could make on a real estate investment property after subtracting vacancy losses and operating costs from your gross operating income. It's a helpful metric for real estate investors who are looking to make informed investment decisions and efficiently evaluate a property's profitability in the real estate market. In addition, current property owners can use NOI to help them determine their property's value, and whether or not they need to raise rents to increase their cash flow.

The NOI formula involves subtracting the total operating expenses from the total revenue earned by a property, which helps investors determine their return on investment. It takes into consideration all possible forms of income such as potential rental income, parking fees, and the income earned from laundry machines and vending machines. It also considers the total operating expenses including property taxes, property management fees, legal fees, janitorial fees, utilities, and repair costs.

NOI does not, however, take personal income taxes into consideration, nor does it include debt payments, debt services, mortgage payments, mortgage interest expenses, depreciation, capital expenditures, or amortization in its calculations.

The simplest way to calculate NOI is to subtract your total operating expenses from your gross operating income (GOI). Your GOI represents the total amount you could make off potential renters minus your vacancy and credit losses (unpaid rent). The standard net operating income formula is as follows:

Net Operating Income = Gross Operating Income – Operating Expenses

Both borrowers and lenders use NOI calculations in a number of ways.

1. 1. Rate of return: Borrowers and lenders use NOI to determine whether an investment will yield a high rate of return, also known as the return on investment (ROI). The larger the NOI, the greater the potential profit. A net operating income below zero indicates a net operating loss, meaning the money a property brings in does cover the cost of operating it.
2. 2. Capitalization rate: NOI comes into play when determining a property’s capitalization rate. Investors calculate a property’s capitalization rate, or cap rate, by dividing a property’s NOI by its purchase price.
3. 3. Sale price: Property sellers and buyers use NOI to determine a fair market value for a piece of rental property or commercial real estate.

All investments, including real estate investments, come with inherent risks which may involve the depreciation of assets, financial losses, or legal ramifications. The information presented in this article is for educational, informational, and referential purposes only. Consult a licensed real estate or financial professional before making any legal or financial commitments.

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