If you google the term “metrics used for rental properties,” the 54 million results offer a plethora of acronyms and phrases, presented as thought leadership articles and blogs in the format of “Top-10” listicles or “important metrics” information..
One such measurement frequently popping up on these lists and/or articles is net operating income, or NOI. The NOI could be considered the real estate investor’s version of a business’s income statement. This number helps you determine a buy-sell investment strategy, or steps you can take while owning a particular property. Summing this up, understanding your rental property’s NOI can help you determine your target property’s potential profitability.
Net operating income is what’s left over when you subtract all reasonable operating expenses from the gross income generated from your rental property. Here’s the formula:
NOI = Total Income – Total Operating Expenses
Now let’s break these terms down.
Describing “total income,” also known as “total revenue” is straightforward. Total income is defined as compensation received in exchange for offering a specific product or service. When it comes to real estate, the IRS defines rental income as any payment received from the use or occupation of a particular property.
But if you own rental property, you might receive additional income from amenities. These could include charging for parking, storage, or on-site package lockers. Or you could generate revenue from laundry facilities or vending machines.
Total Operating Expenses
While total income is derived from your property’s operations, total operating expenses describes the costs associated when it comes to operating that asset. These are known as “operating” expenses, as they take into account what you pay to successfully keep that property going. Such costs include, but aren’t limited to, the following:
- Maintenance and repairs
- Property taxes and insurance
Keep in mind that debt, income taxes, capital expenditures, or depreciation are NOT operating expenses. While these are property costs, they aren’t costs connected with the asset’s daily operations. Rather, these expenses fall under the categories of finance, personal taxes, or property improvement.
Why NOI Is Important
NOI could be considered an essential metric among many for the following reasons:
- It could help you decide whether to purchase or sell a real estate asset.
- It might tell you whether you need to adjust your property’s income (by increasing rent or the cost of other amenities) or reduce expenses.
- It could provide your lender with important information as related to financing.
The NOI is also part of cash flow and capitalization rate formulas. These metrics, and others, can be useful when it comes to comparing properties and determining investment strategies.
To summarize, net operating income is one of many metrics and numbers affiliated with property values and operations. While it boasts a fairly straightforward calculation method, the NOI can be an important tool when it comes to determining real estate and portfolio strategies, adjustments, and approaches.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice, meeting the particular investment needs of any investor. All investments have an inherent level of risk. You could receive back less than you initially invested and positive cash flow or income are not guaranteed. Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.