Table of Contents
- What Are Netting Escrows & How Does It Work?: The Best Guide - January 2, 2024
- The Secret About Prescriptive Easement: Top Guide 1 Must Know - December 4, 2023
- About Home Equity Loans In Texas And How Can One Obtain It - November 27, 2023
About Net Operating Income
Having good financial knowledge is a key to good real estate investment profile. As a real estate investor, there are many things that you need to assess for the properties that you are investing in.
One of the most significant computations that you need to know as a real estate investor is Net Operating Income (NOI). In this post, we will understand what is net operating income in detail.
What Is NOI (Net Operating Income)?
Net operating income, also known as NOI, is a formula used in real estate to quickly calculate the return on a given investment property.
NOI determines turnover and returns on real estate investment after deducting required operating costs.
To calculate your NOI, you must deduct the operating expenses of the property from the income you accrue from the property.
Apart from rental income, investment properties can also generate income from amenities such as parking, laundry, and vending machines.
Operating costs include the costs of operating and maintaining the building, including insurance premiums, legal costs, utilities, property taxes, repair costs, and cleaning costs.
The calculation of NOI may not include some major expenses like the cost of installing a new air conditioning system for the entire building.
NOI calculation helps real estate investors to discover their market capitalization rate.
This will also assist to calculate the value of the investment property, allowing comparing different investment properties that they may consider purchasing or selling.
For property that is financed, NOI is also used to calculate the debt coverage ratio (DCR), which tells lenders and investors whether real estate income will cover operating expenses and debt repayment.
NOI is also used to calculate the cash return on investment, the total return on investment, and the net profit multiplier.
How To Calculate NOI And Its Formula?
The formula to calculate the NOI is not a complex one. Only a few things that you need to have handy and you will be able to know the NOI of a given investment property. Below is the formula:
Net Operating Income = (Rental Income + Additional Income) – Property Operating Expenses.
NOI calculation Example:
Let’s assume you are the owner of a condominium unit that you are renting out. To calculate the NOI, you have the below-mentioned figures:
Rental Income = $30,000
Additional income:
Vending machine: $5,000
Laundry machine: $1,500
Parking charges: $4,000
The gross income generated by your condominium is $40,500.
Property Operating Expenses:
Maintenance and Repairs: $5,000
Property management Charges: $3,500
Property Taxes: $6,000
Insurance: $1,500
The total operating expense for this property is $16,000.
Hence,
NOI= (Rental Income + Additional Income (40,500)) – Property Operating Expenses (16,000).
NOI= 24,500.
Hence this condominium the NOI is $24,500. With the help of this figure, you can now calculate your debt-to-service ratio, compare NOI from other potential investment properties, and know the capitalization rate.
How To Use NOI To Calculate Capitalization Rate?
If you’ve ever been in real estate investing, you’ve probably heard the term “capitalization rate” a few times. NOI also helps the investor to calculate the capitalization rate.
The cap rate is one of the quickest ways for investors to gauge the return potential of a particular real estate investment.
The capitalization rate is also known as return on investment (ROI), however, in the industry cap rate is the term that is most widely used. Below is the formula to calculate the cap rate.
Cap rate = NOI/Sales price
In our above example, let’s assume that you want to sell the property for $325,000. By using the above formula the cap rate for the property would be $24,500/325,000 which is equal to 7.53%.
Depending on how much the investor wants to profit from the investment, the cap rate can be used to analyze potential returns on the investment property.
Whether 7.53% is good enough to invest, is the call that may depend on the market and investor’s expectations.
Conclusion
Net operating income is just one way to help investors to make an informed decision about buying or selling an investment in real estate.
To calculate NOI in real estate make sure that you have accurate information regarding the total revenue generated and the total operating expenses to get a more accurate NOI.
