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How To Calculate Net Operating Income: Definition And Formula
Last Updated on: June 17th, 2023
If you are dealing on real estate properties for the first time, you will come across terms such as Net Operating Income. What does this term indicate? Well, it is used to show the profitability of a real estate property.
The term helps identify all income generated from real estate. But, it excludes all the net expenses done on the property within a year. Real estate property owners need to know about the real estate market of their preferences. They need to have knowledge to estimate and restructure real estate costs, and know about different terms like the NOI.
As a real estate owners, you need to understand different terms, such as NOI, to make uniform and beneficial financial decisions. Go through this article to understand the term clearly and how it works.
What Is NOI Or Net Operating Income?
Net operating income, or the NOI of a real estate asset, allows investors to calculate its profitability. The process subtracts all the operating expenses from the income generated from specific real estate properties.
NOI is used in the commercial real estate industry. Investors use this term to calculate the profitability of properties such as apartments,warehouses, complexes, buildings, and more.
The NOI is measured before the income from a real estate property is filed for tax. It appears on the income and cash flow statement of a property. when used in other industries, the same metric is called EBIT. EBIT stands for earnings before interests and taxes.
The formula for calculating NOI requires minutely figuring out all the incomes generated from a real estate property, then subtracting all the general expenses done on it. These expenses include maintenance fees as well as professional assistance and insurance fees. The calculation of the NOI is done annually rather than doing it quarterly or monthly.
| Key Points ? The net operating income of any real estate property is calculated before adding any tax or financing costs to it. ? One has to subtract all the operating expenses from the gross operating income incurred during a year. ? The operating expenses in the NOI can change if the property owner defers or accelerates specific expense or income metrics. ? You cannot include capital expenditure in NOI. ? A property owner can decide if owning, maintaining, and renting a property is worth it or not, by calculating its NOI. |
How To Calculate Net Operating Income?
The NOI calculation process might seem difficult and more complex for different businesses. However, I have made the calculation simple for you. Here is the NOI formula ?
| Gross Operating Income ? Operating Expenses = NOI/ Net Operating Income |
Yes, it is simple and easy. But you may have to undergo a rigorous process to get information on two of the necessary metrics given here. You need to go through a few steps to get the data on two required metrics for calculating Net operating income.
The easiest way to start, is by calculating the gross operating Income from the gross potential Income. The gross potential Income suggests the amount you can earn from the real estate property when all the rental spaces are filled. But, you cannot include lost incomes the property could potentially generate from the real estate property if there were no empty rental spaces.
Once you have gathered the full Income from the filled-out rental spaces on the real estate property (excluding the empty spaces), you have your gross operating Income. Now, you have to calculate your Net Operating Expenses.
Then, you have to subtract the operating expenses, also referred to as OPEX in real estate, from the gross operating Income to calculate your NOI. The operating expenses usually include – utilities, maintenance, exterior work, insurance, property tax, and management. Once you have gathered your operating expenses on the real estate property, you are ready to calculate your net operating Income.
Calculate Net Operating Income: Example
Say, you have a real estate property, more precisely, an office building. Here is some information about the building ?
Office Building Space: 80000 sq. ft.
Rental Rate: $25 per sq. ft. annually.
Gross Potential Income: 80000 x $25 = $20,00,000
Additional Income: $30000 annually.
Once you have this data ready, you can calculate the gross operating Income of your property. But, let us say you have 3000 sq. ft vacant space that you could not rent out. Then you have to subtract the amount you could have earned from that vacant space if it were filled.
Gross Potential Income: $20,00,000
Additional Income: $30000 annually.
Vacant Space Income: 3000 sq. ft x $25 = $75,000
Gross Operating Income: $20,00,000 ? $75,000 = $19,25,000
So, the above steps gave you the gross operating Income, you have to calculate the gross operating expenses to calculate net operating income.
Here are a few pieces of information you need to gather to calculate your net operating expenses ?
Net Operating Expenses
| Property Tax | $200,000 |
| Building On-Site Management | $850,00 |
| Utilities | $60,000 |
| Insurance | $65,000 |
| Maintenance | $80,000 |
| Total Operating Expenses | $4,90,000 |
Now that we have the Net operating expense and gross operating income, we can easily calculate the Net Operating Income.
NOI: $19,25,000 ? $4,90,000 = $14,35,000
Factors That Affect The Net Operating Income
The cap rate and the net operating income can increase and down based on a few factors that manipulate the metrics. Here are some of those factors ?
Rental And Vacancy Rate
Rental income can be profitable if the owner can take control of a few things, such as ? increasing rental rates, filling out vacancies, and collecting delinquent rates. On the contrary, lower rental rates, more delinquencies, and vacancies can lower the Net operating income from a real estate property.
Operating Expenses
The operating expense is another factor that can affect the net operating income of real estate property. Insurance and maintenance costs can increase. Similarly, the property tax can also increase, making the property tax rise or fall.
Changing Market Conditions
Due to a change in the economy or the market, real estate properties might face delinquencies or vacancies, causing the net operating income to differ from expectations.
Bottom Line
Dealing with real estate properties requires investors to look at different metrics. Net operating income is one of them. It helps investors calculate the profitability of a property. Once an owner has an idea about the NOI from a property, they will know if the income generated by the property will be profitable or not. Once you go through this article, you will have a clear idea about this term.
However, if you want to know more about the same or have related queries, you can let us know through the comment section.
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All Comments
Optymalizatory Modułów Fotowoltaicznych
24th April, 2024
This post really opened my eyes to new perspectives. Thanks for such an informative and well-written article.