Home Insights Calculating Net Operating Income (NOI): A Quick Review

Calculating Net Operating Income (NOI): A Quick Review

by Jackson B

Net operating income (NOI) is an economic measurement used to analyze the overall profitability of specific income-producing real estate properties. NOI is calculated by deducting all necessary operating expenses from the net proceeds generated by the sale of a property. All costs involved in maintaining a property are also taken into consideration. If the property generates a net profit, then the net operating income earned by the property can be considered as a positive cash flow. A negative cash flow indicates the need to borrow funds to support the operations needed to generate the profit.

Real estate values usually appreciate over time. Potential rental income on your investment property is based on the expected rent amount as well as future traffic patterns that could earn you extra money from your tenants. In order to calculate this, potential rental income is estimated using historical sales data. Net operating income can be further improved by comparing it to the gross rental returns on investment.

The total cost of maintaining a property is included in the equation of net operating income. Depending on the kind of property being invested in, the maintenance expenses could easily exceed the cash flows earned. One way to decrease this burden is through downgrading the maintenance activities to reduce maintenance cost and extend the useful life of the asset. For example, installing a modern heating system would reduce required capital outlay for heat pumps and other costly mechanical devices. This will improve profitability.

Several ways have been used to introduce equity into a non-performing commercial property by utilizing noi real estate formulas. This involves injecting cash flows based on future returns. This is done by either using short-term or long-term financing systems. Short-term financing systems are typically used by first-time investors. On the other hand, long-term financing systems are usually used by more mature investors who have had substantial experience in dealing with similar businesses in the past.

A simple method of introducing equity into a property is by means of selling it for an amount that represents its net worth at the date of sale. This is also known as fair value. Many real estate investors use this method to calculate net operating income since it involves no immediate cash outflow. When using this method, the difference between the fair value and net value is then applied as profit and loss. When the profit is greater than the loss, the value of the real estate is depreciated and it becomes ready for re-sale.

There are many real estate investors who use the method of negotiation to introduce equity into a non-performing asset. Negotiation is often used when the net operating income of the particular piece of property is not sufficient to justify the purchase. For instance, if the investment has only a 20% chance of becoming profitable, the investor may not want to buy it. On the other hand, if it is deemed to be a reasonably good deal, the price may be negotiated down to bring the net operating income closer to the actual profitability level.

The ability to calculate net operating income can be complicated by the use of the terms’ cash flow and profit and loss. Many investors are unfamiliar with net operating income because of the numerous terms that are commonly used in the industry such as EBIT – Earnings before Interest & Tax (EBIT is also sometimes referred to as Employer’s Cost), Property, and Casualty (CP) Costs. Therefore, it is important that an investor familiarizes himself with the various terms and definitions in order to be able to make sound financial decisions.

Net operating expenses are those expenses incurred during production or processing of tangible goods that depreciate in value. These include inventory, fixed assets, plant and machinery costs, and travel expenses. Capital expenditures are the cost of building and maintaining plant and equipment and construction supplies. Net operating income generated from operating expenses consists of the net effect of these three components, less any gross margin that may be applied. It should be noted that the term ‘net operating income’ is not identical to the term net profit on accounts.