To consider the potential profitability of a real estate investment, there is a calculation called the net operating income (NOI). The calculation is done by taking the revenue earned from the real estate investment minus any operating expenses.
Income from a property includes the money coming in from the day-to-day business operations. For example, when considering the income of a property, the following are usually included:
- Rent collected
- Fees for parking
- Income from laundry or vending machines
The NOI only includes the effective rental income, which is the amount of rent actually being collected. It does not consider rent from units that are unoccupied or tenants who fail to pay.
Examples of necessary operating expenses for an investment property include:
- Property management fees
- Administrative expenses
- Attorney fees
- Property taxes
- Utilities not paid by tenants
The calculation does not include expenses that are not related to the day-to-day operations of the building. This might include:
- Principal and interest payments
- Lease commissions
- Income taxes
- Amortization or depreciation
- Capital expenditures
Capital expenditures differ from maintenance and repair and include major upgrades like a new roof or air conditioning unit.
Consider a 20-unit rental property that has a potential rental income of $50,000 if there are no vacancies. However, two units sit unoccupied, totaling $5,000 in vacancy losses. The effective rental income would be $45,000. If necessary operating expenses are $25,000, the NOI would be $20,000.
Evaluating the NOI of a property can help investors gauge whether it might be a strong income producing investment after considering the necessary expenses to run the property. If a property is operating at a loss, it is referred to as a net operating loss.
To understand what expenses to use in calculating NOI, it is always best to consult with a financial advisor.