Net Operating Income, or NOI is the basis of Real Estate value under the Income Capitalization Approach.  It is the single most important metric that a savvy investor will want to know when looking to purchase income-producing property. Once an investor knows the NOI of a property he or she can quickly figure out its value by simply dividing the NOI by the Market Cap Rate. 
Remember, investing in Real Estate is a business, and some businesses are more profitable than others!
Some investors look for properties that may have an upside by doing some renovation in hopes to raise the rent. They may also look for ways to lower operating expenses. Both of these techniques will raise the NOI and thus the VALUE of the property!
The basic rule of thumb is: The higher the rental income and the lower the expenses, the higher the NOI.

How to Calculate NOI

Gross Operating Income (-) Gross Operating Expenses = NOI
To calculate NOI, you simply subtract your gross operating expenses from your gross operating income.
In other words, Net Operating Income is the gross operating income of the property less any operating expenses.

Calculating Gross Operating Income

The generally accepted way to calculate gross Operating Income amongst investors is as follows:
Potential Base Rent (contract rent and vacancies marked up to market rent)
  • (+)Potential Reimbursables (things like utilities, tenants’ pro rata shares of property taxes, common area maintenance, etc.)
  • (=) Potential Rental Income
  • (+)Other income Subject to Occupancy (things you make money from tenants on like laundry machines, vending machines, parking spots, etc.)
  • (=) Potential Rental IncomeSubject to Occupancy
  • (-)Vacancy & Credit Loss (typically you will subtract 5% from your “Potential Rental Income Subject to Occupancy” to account for vacancies, late payers, or other losses)
  • (=) Effective IncomeSubject to Occupancy
  • (+)Other Income NOT Subject to Occupancy (additional things you make money on whether the property is leased or not- billboards, cell phone towers, naming rights, etc.)
An important thing to notice is that reimbursable expenses such as utilities are treated as income and then later subtracted as expenses. This is due to the fact that you would still have to pay them if you did not have a tenant so they are also subject to the vacancy and credit loss factor.

Virtually all properties will be subject to these expenses:

  • Property taxes
  • Utility bills
  • Rubbish collection
  • Janitorial services
  • Landscaping costs
  • Pest control
  • Fire safety (fire extinguisher, alarm tests, etc.)
  • Repairs & Maintenance
  • Insurance
  • Management fees
  • Allowances for Tenant Improvement
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