What is NOI in Real Estate?

Net Operating Income (NOI) is a crucial financial metric used in real estate investing to evaluate the profitability of a property. By focusing solely on the property's operational performance, NOI provides a clear picture of how efficiently a property is being managed. Investors use NOI to assess the value of a property, determine its potential return on investment, and compare different investment opportunities.

Continue reading to learn about the uses of NOI in real estate.

How Do You Calculate Net Operating Income?

Calculating NOI in real estate is a simple formula that takes into consideration all income and expenditures per property into one comprehensive calculation. The NOI formula is a powerful tool for investors because it succinctly expresses all income minus all the general expenses in a single figure.

A single property may have multiple revenue streams, earning money from tenant rents, parking fees and vending machines. Operating expenses aren’t just maintenance fees but also expenses like insurance and professional help for marketing, tenant management, inspections and appraisals.

NOI Formula

The formula for NOI is:

Net Operating Income = (Gross Operating Income + Other Income) - Operating Expenses

Here’s NOI in real estate in action — assume your gross operating income from a commercial retail space is $60,000 per year, and you also make $10,000 per year in parking fees from the same property. If operating expenses, including insurance, maintenance, and utilities, are $10,000 per year, the NOI is $60,000.

Net Operating Income = ($60,000 + $10,000) - $10,000 = $60,000

NOI in real estate is a before-tax figure comparable to the earnings before interest and taxes (EBIT) used in other industries. It looks at the profitability of a property before adding costs from financing or taxes.

Income

Income includes any revenue generated from the property, from rental income to agricultural production to vending machines or parking fees. Common sources of real estate income include:

• Rental income
• Fees
• Deposits
• Farmland income
• Parking rental income
• Restaurant income
• Laundry income
• Vending machine income
• Gym or spa income
• Any other income, fees or royalties collected in relation to the property

Expenses

Operating expenses in real estate encompass all costs of buying, selling, maintaining and renting properties. This can include:

• Amortization
• Interest on loans
• Capital expenditures
• Depreciation
• Insurance
• Utilities
• Maintenance
• Property management
• Appraisal fees
• Home inspection
• Broker fees and tenant screening
• Property upgrades or improvements
• Accounting fees
• Vacancy costs
• Business permits
• Closing costs
• HOA
• Marketing
• Property taxes

Net Profit vs. Gross Profit

Gross profit is what you make before subtracting anything. Net profit is what you take home after deducting taxes and expenses. Gross profit is a single representation of positive cash flow. For the NOI formula, you need to know gross profit. You get net operating income or NOI in real estate when you take gross profit and deduct expenses.

What is the Importance of NOI in Real Estate Investing?

NOI is a critical indicator of a property's financial performance. It provides insight into the property's ability to generate income from its operations, independent of financing or tax considerations. Generally, a higher NOI indicates better performance and greater cash flow potential. Investors use NOI to gauge a property’s performance.

A property with a low NOI may have good investment potential, especially if the investor can highlight key renovations or upgrades that will yield a strong return on investment (ROI) and better NOI. Likewise, watching NOI over time can give you an idea of how well a property is doing. A continuously decreasing NOI may indicate it’s being mismanaged or lacks profitability potential. In this way, NOI indicates that you need to address management issues or consider selling.

NOI is also used to calculate the debt coverage ratio for financed properties. This tells lenders and investors whether a property’s income covers its operating expenses and debt payments. NOI is also used to calculate cash return on investment, the net income multiplier and total ROI.

How to Interpret Net Operating Income

Interpreting and analyzing net operating income figures in real estate is relatively simple. The larger the number, the better the cash flow and total profit. NOI is important, as opposed to gross income.

Here’s an example of why you need NOI and not only gross income:

A building could have $1 million a year in gross income and $1 million in expenses, making its NOI $0. If you only considered the revenue, it would look like an exceptional investment. But without significantly reducing expenses, the NOI doesn’t make sense.

Key considerations and factors to take into account when evaluating NOI to gain insights into the financial health and performance of a property are the locations, historical performance and volatility of the market, as significant vacancies and turnover will cut into potential future profits.

Ways to Maximize Your Real Estate NOI

If your property has a low NOI, all is not lost. Actionable strategies and techniques to maximize NOI in real estate investments include minimizing expenses, increasing rental income and generating income from other amenities and services. Here are practical tips and advice for reducing operating expenses and increasing rental income, ultimately leading to improved NOI.

Minimize Operating Expenses

Minimizing operating expenses begins with looking hard at where funds are going and where reductions are possible. This can include:

• Implementing cost-saving measures
• Improving efficiency in property management and maintenance
• Using technology and automation

Initial areas where cost-cutting is generally possible are:

• Utility usage (cut back or consider installing solar for energy)
• Security or management hours
• Maintenance and garden expenses

In addition, each company will need to consider its unique business model, where time and costs are used and where they can be reduced.

Increase Rental Income

In many ways, increasing income is easier than cutting costs. Conduct market research for optimal pricing. Consider which upgrades may increase the value and the rental prices you can charge. For example, you can enhance property amenities and features at a mall, hotel or business space and then charge premium prices.

Finally, increasing rental income will generally require implementing effective marketing and tenant retention strategies. Vacancies will cost more than incremental increases in rent, so the first priority should be tenant retention. Additionally, you can consider listing rental prices at a higher rate that are commensurate with the upgrades and current market conditions.

Charge Fees for Amenities and Services

While offering better service can lead to higher client retention, depending on the type of real estate, it’s worth considering fees for extra amenities or services. Start by identifying potential revenue-generating amenities, dependent on the property and location. Common possibilities include a coin-operated laundry, adding parking fees or vending machines.

Implement fee structures and agreements with tenants that cover additional amenities, ideally billed monthly with rental income. Finally, as related to the above, provide premium services for additional income. Instead of a coin-operated laundry, offer a laundry pick-up and delivery service that includes dry cleaning for all tenants twice a week or consider offering wellness courses, an ATM or an in-house hair salon.

Does NOI Include Real Estate Taxes?

NOI includes real estate taxes paid on the property's value, including the cost of land and anything permanently affixed to the land. However, it does not include individual income tax paid by the owners or corporate tax in the case of a corporate owner.

Pros of Using NOI for Evaluating Real Estate Investments

There are significant advantages to using NOI as a metric in real estate investments and management. It is widely recognized and valued by industry professionals as a measure of profitability. Pros of using NOI include:

• Demonstrates profitability
• A high NOI can help secure financing
• Used to calculate the cap rate on commercial real estate investments
• Indicates whether a property is worth current expenses
• Provides a guide to possible improvements that can increase NOI
• Widely accepted and used for commercial real estate

Cons of Using NOI for Evaluating Real Estate Investments

While there are no true cons to using NOI, it does come with some limitations. These include:

• Doesn’t account for individual income taxes
• Doesn’t provide a complete picture of a property's financial performance
• May not be accurate across time in highly volatile markets

Using NOI in Real Estate Investing

NOI is an initial assessment tool that you can use to gauge a property’s profitability and invest for your goals. Whether you’re new to real estate investing or already own several properties, NOI can be used to calculate cap rates, estimate ROI for renovations or improvements and provide insights for additional income-producing activities. If you’re ready for the next steps, learn more about how to create wealth investing in real estate here.

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