Net Operating Income Calculator
We have prepared this net operating income calculator (NOI calculator) so you can calculate the net operating income of real estate property. NOI is one of the best metrics to analyze the profitability of your real state property, as this metric can be understood as the operating profit of a real estate property.
The following article will help you understand what net operating income is and how to calculate it using the net operating income formula. We will also demonstrate some practical examples to better help you to understand the metric.
NOI definition. What is the net operating income?
Net operating income definition, or NOI for short, is equivalent to the operating profit generated by a real estate property. It is calculated by deducting operating expenses from the income generated by the property. This metric is one of the most widely used metrics to assess the profitability of real estate.
Net operating income is also often interpreted as the cash flow generated by a real estate property. Hence, it is also the main metric to be used in real estate valuation. Investors often substitute cash flows into a discounted cash flow (DCF) model with NOI when valuing real estate.
Now that we can answer "What does NOI stand for?" and understand the meaning of the net operating income of real estate, let's talk about how to find net operating income.
How to calculate net operating income? The net operating income formula
Without further ado, let's look at how to find the net operating income. We will use a sample real estate property with the following information as an example:
- Area: 1,500 square feet (~140 m²);
- Rental per square area: $300 per year;
- Parking rental: $2,000;
- Occupancy rate: 85%;
- Property tax: $20,000 per year;
- Property management fees: $14,000 per year;
- Insurance: $19,500 per year;
- Maintenance: $18,000 per year;
- Repairs: $24,500 per year; and
- Other operating expenses: $17,000 per year.
The following are the steps to calculate the net operating income of the real estate property:
- Determine the potential gross income
potential gross incomeis the sum of the
full rentalof the property and
full rentalis the rental obtained without considering occupancy rate, and
other incomeis the income other than rentals. The formula is shown below:
potential gross income = full rental + other income,
full rental = area * rental per square area
full rentalof the example property equals
1,500 square feet * $300 per square feet = $450,000.
other incomeequals the parking rental. Hence, the
potential gross incomeof the property is
$450,000 + $2,000 = $452,000.
- Determine the effective gross income
effective gross incomeis equivalent to the income from the property after deducting
vacancy lossis defined as the loss due to not renting out some part of the property. The formula is shown below:
effective gross income = potential gross income - vacancy loss,
vacancy loss = full rental * (1 - occupancy rate)
For the property in question, the
vacancy loss = $450,000 * (1 - 85%) = $67,500. Thus, the
effective gross incomeof this property is
$452,000 - $67,500 = $384,500.
- Calculate the operating expenses
operating expensesare defined as the expenses incurred as part of operating the real estate property. In general, there are 6 main operating expenses for managing property, namely:
property management fees;
other operating expense.
You can specify the above values in the
advanced modeof our net operating income calculator. The formula to calculate the
operating expensesis shown below:
operating expenses = property tax + property management fees + insurance + maintenance + repairs + other operating expenses
For our property, the
$20,000 + $14,000 + $19,500 + $18,000 + $24,500 + $17,000 = $113,000.
- Calculate the net operating income
Finally, it's time for us to calculate the property's
net operating income. The
net operating incomeformula is shown as below:
net operating income = effective gross income - operating expenses
net operating incomeof the property is
$384,500 - $113,000 = $271,500.
Note, that our NOI calculator uses the same NOI formula as presented above. So, if you still have doubts about how to calculate NOI, our tool has you covered!
How to interpret the net operating income (NOI)?
Net operating income (NOI) is the most critical metric when analyzing a real estate property, so it is worth it to know how to calculate NOI. Let's talk about how we can interpret it to analyze real estate.
Firstly, NOI is the most important metric in your mortgage application. If the real estate has a negative NOI, it is almost impossible to obtain a loan for the property. Furthermore, the higher the net operating income, the easier it is to obtain a mortgage with a low interest rate.
Moreover, NOI can be increased by decreasing operating expenses. This might seem like an excellent option to increase the NOI of your property. However, lower operating expenses might impact the quality of real estate. This might cause your tenants to leave, hence lowering your occupancy rate and increasing your vacancy loss. So, it is essential to assess if the operating expenses are unnecessary before deducting them.
Lastly, although NOI is a powerful metric, it is still subjected to manipulations. A property owner can falsely increase this metric by deferring some operating expenses to the next period. Thus, it is vital to carry out detailed due diligence on a property before making a deal.
Can net operating income be negative?
Yes, net operating income can be negative. This happens when the effective gross income is less than the operating expenses of the property.
Does net operating income take vacancy into account?
Yes, net operating income takes vacancy into account. Net operating income is calculated by deducting operating expenses from the effective gross income, which is the difference between potential gross income and vacancy loss.
What are the operating expenses of a real estate property?
Managing a real estate property can incur a lot of costs. Here are some more prominent ones that you should pay attention to:
- Property taxes;
- Property management fees;
- Repairs; and
What is the difference between net operating income and net income?
Net income is the bottom line of the real estate property, while net operating income is similar to operating profit. Net operating income only takes operating expenses into account, whereas non-operating income is deducted to form net income.