Net Operating Income (NOI): What Is It And How Do You Calculate it?

Net operating income (NOI) is a calculation used to measure the profitability of real estate investments. NOI is determined by subtracting a property’s operating expenses from its total revenue.

Understanding this metric can help you evaluate potential investments and make better financial decisions. This article will explain what NOI is, what’s included and how to use the NOI formula.

What Is Net Operating Income (NOI)?

Net operating income is a metric for calculating the profitability of an investment property after subtracting the overhead costs. Investors and lenders use NOI to compare rental properties and make decisions about profitability. It’s often used in commercial real estate to evaluate office buildings, apartments or warehouses.

For example, let’s say you own an apartment complex and make money by renting the units out to tenants. To determine NOI, you must subtract the property’s operating expenses from the revenue it generates.

The operating expenses include things like building maintenance, utilities, insurance premiums and legal fees. And the property may generate income from parking, vending machines and laundry services in addition to rental income.

NOI Formula

You calculate NOI by subtracting your operating expenses from the gross operating income. Here’s the formula you’ll use:

Net Operating Income = (Gross Operating Income + Other Income) − Operating Expenses

In this equation, the gross operating income typically refers to any rental income. Other income refers to any additional income the property brings in outside its primary source of revenue. Operating expenses refers to any costs that go into running and maintaining the property.

How To Calculate NOI

Let’s look at the steps you’ll take to calculate NOI:

 

For example, let’s say you have a property that generates $200,000 a year in gross operating income and incurs $50,000 in expenses. That means the NOI for this property is $150,000 per year.

What Is Included in Gross Operating Income?

Gross operating income represents the total income generated by an investment property. Here are the potential revenue types included: 

What Is Included In Operating Expenses?

Operating expenses are the day-to-day costs that go into running and maintaining the property. Here’s what that typically includes: 

 

What Is Excluded From NOI Calculations?

NOI is designed to help you understand a property’s potential cash flow, how much it costs to maintain and whether the investment is profitable or not. For that reason, certain numbers are excluded from NOI calculations.

 

Here are the biggest factors that aren’t included in NOI calculations and why they’re left out: 

 

NOI Calculation Example

Here’s an example that can help illustrate how the NOI calculator works:

 

Let’s say you purchased a small apartment building that brings in $200,000 annually between the rental and amenity fees. In addition, you must account for the following expenses:

 

 

That means the total operating expenses are $48,000. From there, you’ll calculate NOI using the following formula:

 

$200,000 – $48,000 = $152,000

 

That gives you a net operating income of $152,000 per year. 

Net Income Vs. Net Operating Income

The net income is the total income earned by an investment after subtracting all expenses. This includes operating and non-operating expenses like interest paid on debt, depreciation and taxes. In comparison, net operating income is the total income earned after subtracting the expenses associated with operating the property.

 

The goal of net income is to provide a comprehensive view of a property’s profitability after all financial factors are considered. Whereas net operating income focuses solely on an investment property’s operating expenses.

Net Operating Income Vs. Cap Rate

The capitalization rate is another metric investors use to quickly assess a potential’s investment property’s profitability. The cap rate is expressed as a percentage and shows the relationship between the property’s NOI and its purchase price.

 

Here’s the formula used to calculate the cap rate:

 

Capitalization Rate = Net Operating Income∕Purchase Price

 

For example, let’s say the apartment in the previous example is listed with an asking price of $500,000. That means the property has a cap rate of 10%. Investors can compare this cap rate to the cap rate of other potential investments.

 

What’s considered a good cap rate will vary depending on the property type of location, but most market analysts recommend a cap rate between 5% and 10%.

The Bottom Line

NOI is an important financial metric that can help you evaluate the profitability of a potential real estate investment. However, it’s important to remember that certain expenses aren’t included in NOI calculations.

NOI is a baseline that investors can use to compare different properties and evaluate the potential profitability of an investment. It’s not a fair comparison of all the costs that will go into buying and maintaining an investment property.