Net Operating Income (NOI)
Net operating income (NOI) is the profitability ratio which used by the real estate. From the calculation of income after the deducting of the expenses, property profit and the financial health of the company can be measured by using this ratio.
In other words net operating income used to measure the cash flow amount after the payment of all expenses.
For the evaluation of the single property, investors and creditors use this ratio to find that the property for the investment is good or bad.
For the evaluation of the initial price, they use this ratio. e.g investors measured that how much price they finalized so that after the payment fall expenses they can make money.
This ratio not only use for the real estate only. Other industries refer this ratio as EBIT.
Net operating income formula can be calculated by subtracting the operating expenses from gross income.
Net operating income = Gross income – total expenses
Revenue not only the rent of the property but it has different more income. Some resources of revenue listed below
- Rental income
- Parking fee
- Vending machine
- Laundry machine
- Service charges
Operating expenses are those expenses which generate from revenue-generating activities. In other words for the maintaining of the property, all the required expenses are called operating expenses. Some of the operating expenses are below
- Property management fee
- Property tax
For a better understanding of net operating income (NOI), we take the example.
Lee owns the Real Estate business and purchased the potential rental properties and existing rental properties. He wants to invest the money to run his business more efficiently. Lee evaluates 2 apartment which has the values on the income statement listed below.
Apartment # 1
- Rental income = 100,000 dollars
- property anagement fee = 20,000 dollars
- Property taxes = 15,000 dollars
- Insurance = 10,000 dollars
- Repairs = 20,000 dollars
Apartment # 2
- Rental income = 50,000 dollars
- property anagement fee = 1,000 dollars
- Property taxes = 1,000 dollars
- Insurance = 2,000 dollars
- Repairs = 1,000 dollars
Now we find the NOI ratio for both apartment to measure that investment on which apartment is better.
Net Operating Income for Apartment 1
35,000 = 100,000 – 65,000
Net Operating Income for Apartment 2
45,000 = 50,000 – 5,000
Revenue generated by the first apartment is more as compared to the second apartment but also fist apartment has more expenses. NOI ratio of the second building is high as compared to the second building. So investment in the second building give a better result but we need to consider other things.
There are many calculations which used to find the worth of the rental property but NOI equation give good result and through this, we examine all the expenses. Through this, by examining the expenses we find how the future cash flow will be affected.
If the building is new then no need for the repairs expenses then the calculation of above 2 apartment will be different. It means that expanses greatly change the worth of the property. Expenses make the property more or less attractive for the investors.
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