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Net Operating Income: How Much Does Your Commercial Property Earn?

Net operating income (NOI) reflects the value of a revenue-generating property, which would be of use to commercial real estate owners and investors. Calculating the NOI of a property would help you gauge a building’s income stream.

What is net operating income?

Net operating income in real estate helps investors identify whether a property presents a worthwhile opportunity. All revenue streams from the property are included in NOI, such as rent and fees for parking or laundry services. Operating expenses, like property insurance and maintenance, are subtracted from the total revenue to show how much the property is truly earning after expenses are paid.

What’s not included in NOI

NOI does not reflect the impact of non-operating expenses, such as business income taxes, loan payments or capital expenditures, which include the costs of improvements to the property.

NOI is most commonly applied to commercial real estate — still, any business owner could use it to take a closer look at its financial standing as a regular accounting practice. NOI may also be referred to as EBIT — earnings before interest and taxes. To go a step further, you could calculate your business’s EBITDA — earnings before interest, taxes, depreciation and amortization — to determine the overall worth of the company.

How to calculate net operating income

You can calculate NOI by deducting operating expenses from the revenue that the real estate property generates. Here’s a net operating income formula to follow:

Net Operating Income = Property Revenue – Operating Expenses

Property revenue would be the gross operating income of the building, which would reflect:

  • Rental income
  • Vacancy and credit losses
  • Property related income (fees, vending machines, signage, etc.)

Operating expenses related to the property would include:

  • Property insurance
  • Management fees
  • Property taxes
  • Janitorial expenses
  • Repairs and maintenance
  • Utilities

You would total all of the property revenue and expenses, then complete the calculation to find the NOI. The final number would show how much money the property is actually generating when expenses are taken into account.

Net operating income example

Say a small office building could generate $200,000 annually from rent payments when the building is fully occupied. However, $12,000 has been lost in vacancies. That means the current rental income is effectively $188,000.

The building owner’s operating expenses fall into five categories: property taxes, insurance, maintenance, overhead (such as administration expenditures) and other direct costs. Those costs total $70,000 on an annual basis.

To find the building’s NOI, the owner would subtract the annual expenses from the building’s annual revenue, excluding what’s been lost because of vacancies.

$188,000 – $70,000 = $118,000

Despite having a potential income maximum of $200,000, the building’s NOI is $118,000 after losses and expenses are deducted.

Capitalization rate

A real estate investor deciding to buy this building might take the NOI and compare it with the building’s value. If the building is worth $1 million, divide the NOI by that amount to arrive at 0.118, or about 12%, a figure known as the capitalization rate. The investor would have to determine if 12% is a satisfactory return on investment.

What net operating income means for you

As the owner or buyer of income-generating commercial real estate, NOI can show you the property’s cash flow. Lenders may look at the NOI of the property when deciding whether to lend you money to buy the building or make improvements. Better NOI would indicate a higher likelihood that you’d repay a loan.

NOI can show how well a property is being managed, or how well it’s performing compared to other properties that you own. If you notice NOI decreasing, it could mean you need to take action within the property or put the building up for sale.

Increasing NOI

Adjusting your income or expenses would allow you to improve your NOI. For instance, increasing rent or parking fees while cutting operating costs could increase the building’s NOI. You may see opportunities to reduce overhead, or adopt strategies to retain tenants to avoid vacancy losses. Analyzing your NOI could help you run your property more efficiently.

FAQs

How do you calculate net operating income?

You need to subtract all operating expenses from property revenue to find the net operating income of a commercial real estate property. NOI shows how much income a building generates after eliminating regular operating expenses. You can use an online NOI calculator to help you with the math.

What is included in an NOI calculation?

The NOI formula includes all the revenue a commercial property earns, including income from rent, parking and laundry fees, vending machines and any other income streams. All annual operating costs are also included in the calculation. You would subtract total operating expenses from total revenue to find NOI.

What is the difference between net income and net operating income?

Net operating income illustrates income minus regular, everyday operating expenses. Similarly, net income shows your business income minus expenses, but those expenses include any non-operating costs, such as large, one-time purchases. Understanding both calculations would allow you to see how much your business earns on a regular basis, as well as when you have one-off expenses.

 

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