Net Operating Income - NOI

Net Operating Income (NOI) is equal to a property's yearly gross income less operating expenses. Gross income includes both rental income and other income such as parking fees, laundry and vending receipts, etc.

Operating expenses are costs incurred during the operation and maintenance of a property. They include repairs and maintenance, insurance, management fees, utilities, supplies, property taxes, etc. The following are not operating expenses: principal and interest, capital expenditures, depreciation, income taxes, and amortization of loan points.

Net operating income is calculated as follows.

Income
Gross Rents Possible $100,000
Other Income $1,000
Potential Gross Income $101,000
Less Vacancy Amount $5,000
Effective Gross Income $96,000
Less Operating Expenses $70,000
Net Operating Income $26,000

Net operating income or NOI is used in two very important real estate ratios. It is an essential ingredient in the Capitalization Rate (Cap Rate) calculation that is used to estimate the value of income producing properties. Lets assume we have a market capitalization rate of 10 for the type of property we are considering purchasing. A market cap rate is calculated by evaluating the financial data from current sales of similar income producing properties in a given market place. We are evaluating a similar income property that is currently for sale with a net operating income of $50,000. We would estimate the value of this property like this.

Net Operating Income 50,000 : Capitalization Rate .10
Estimated Value = 50,000 x .10 = 500,000

Another important ratio that is used to evaluate income producing properties is the Debt Coverage Ratio or DCR. The NOI is a key ingredient in this important ratio also. Lenders and investors use the debt coverage ratio to measure a property's ability to pay its operating expenses and mortgage payments. A debt coverage ratio of 1 is breakeven. Most lenders require a minimum of 1.1 to 1.3 to be considered for a commercial loan. From a bank's perspective and an investor's perspective, the larger the debt coverage ratio the better.

Debt coverage ratio is calculated like this.

Net Operating Income 50,000
: Debt Service 40,000
Debt Coverage Ratio = 40,000/50,000 = 1.25

Debt service is the total of all interest and principal paid in a given year. It is equal to the mortgage payment times 12 or the mortgage payments times 12 if you have multiple loans on a property.

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Determine the Real Estate Financial Statistics for a Property

Before you buy an investment property it is critical that you create your own projection of the property's profitability. Real-Estate-Proforma.com has a quick-proforma with which you can calculate real estate financial statistics such as Internal Rate of Return, Capitalization Rate, Cash-on-Cash, Debt Multiplier, Loan-to -Value Ratio, Debt Coverage Ratio, and Mortgage Payments. You can use this JavaScript proforma to project the profitability of a real estate project. By becoming a member you will receive access to a number of Excel real estate proformas. membership | services

If you are analyzing another person's proforma, or you are examining a prospectus for a real estate deal, it is very important that you read the document carefully and determine how the values of the financial statistics above are being calculated. For instance, values such as the Cap Rate may be determined from overly optimistic projections of the future rental income of a property.

You can "reverse engineer" the financial projections you receive from a prospectus and/or request the Excel (or other type of) spreadsheet a developer used to create their proforma. A very useful Excel or Visual Basic macro used to check Excel formulas is available in the spreadsheet below for download. Download Mortgage Formula Excel Spreadsheet

The due-diligence you do on a potential investment may uncover a number of potential problems with a real estate deal and we suggest you research each real estate investment very carefully. There are a variety of real estate financial consultants who can help with this, but if you are like many Real-Estate-Proforma.com members, you can or are learning to do your own due-diligence.

We hope you become a more successful real estate investor by using this site! membership | services