Net Operating Income – NOI Definition

408(k) Plan

What is net operating income – NOI?

Net operating income (PNI) is a calculation used to analyze the profitability of income-generating real estate investments. NOI equals all property income minus all reasonably necessary operating expenses. NOI is a pre-tax figure, shown on a property’s income and cash flow statement, which excludes principal and interest payments on loans, capital expenditures, depreciation and amortization. . When this measure is used in other sectors, it is called “EBIT”, which means “earnings before interest and taxes”.

Key points to remember

  • Net operating income measures the profitability of an income-producing building before adding financing costs or taxes.
  • The operating expenses used in the NOI metric can be manipulated if a landowner postpones or accelerates certain income or charges.
  • The NOI metric does not include capital expenditures.

The formula for NOI is:


Net operating profit=RROEor:RR=real estate incomeOE=exploitation charges begin {aligned} & text {Net operating income} = RR – OE \ & textbf {where:} \ & RR = text {real estate income} \ & OE = text {expenses exploitation} \ fin {aligned}

TheNet operating profit=RROEor:RR=real estate incomeOE=exploitation chargesTheThe


Net operating profit

What does NOI tell you?

Net operating income is a valuation method used by real estate professionals to determine the precise value of their income producing properties. To calculate the INR, the property’s operating expenses must be subtracted from the income that a property generates.

In addition to rental income, a property can also generate income through amenities such as parking structures, vending machines and laundry facilities. Operating expenses include the costs of operating and maintaining the building, including insurance premiums, legal fees, utilities, property taxes, repair costs and janitorial fees. Capital expenditures, such as the costs of a new air conditioning system for the entire building, are not included in the calculation.

NOI helps property investors determine the capitalization rate, which helps them calculate the value of a property, allowing them to compare the different properties they plan to buy or sell.

For financed properties, NOI is also used in the Debt Coverage Ratio (DCR), which tells lenders and investors whether the income from a property covers its operating expenses and debt payments. The NOI is also used to calculate the net income multiplier, the cash return on investment and the total return on investment.

Example of use of net operating profit

Suppose you own a property that generates $ 120,000 in annual revenue and incurs $ 80,000 in operating expenses. In this case, this will result in an NOI of $ 40,000 ($ 120,000 – $ 80,000). If the total is negative, where operating expenses are greater than revenues, the result is called a net operating loss (NOL).

Creditors and commercial lenders rely heavily on NOI to determine the potential income generation of the property to be mortgaged, even more than they take into account an investor’s credit history in their decisions. Simply put: this metric helps lenders fundamentally assess the property’s initial value by predicting its cash flow. If a property is found to be profitable, lenders also use this figure to determine the size of the loan they are willing to make. On the other hand, if the property has a net operating loss, lenders are likely to reject the borrower’s mortgage application right away.

Owners can manipulate their operating expenses by deferring some expenses while speeding up others. NOI can also be increased by increasing rents and other costs, while simultaneously reducing reasonably necessary operating expenses. As an example of the latter, consider a scenario where an apartment owner waives the annual rent of $ 12,000 from a tenant, in exchange for that tenant acting as a property manager. If the owner of the apartment normally paid a property manager a salary of $ 30,000, he could therefore subtract the “reasonably necessary” cost of $ 30,000 from the income, rather than the actual cost of $ 12,000. (For a related reading, see “NOI vs EBIT: compare the differences”)

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