Does Net Operating Income Include Mortgage?
Understand Net Operating Income (NOI) in real estate. Discover how this key metric assesses property performance, independent of financing costs.
Net Operating Income (NOI) is a financial metric in real estate that shows a property’s profitability. It measures the income generated by a property before accounting for financing costs, like mortgage payments, and income taxes. NOI assesses the operational efficiency and earning potential of an income-generating property.
Understanding Net Operating Income
Net Operating Income is calculated by taking all revenue a property generates and subtracting all its operating expenses. Revenue sources include rental income, which is often the primary source, alongside parking fees, laundry income, and vending machine revenue.
Operating expenses are the costs to maintain and operate the property. These include property taxes, insurance premiums, utilities not covered by tenants, maintenance and repair costs, and property management fees. Other operating expenses are landscaping, snow removal, pest control, and professional service fees. NOI reflects the property’s income-generating ability solely from its operations, before considering how it was financed or the owner’s tax situation.
Operating Expenses Versus Debt Service
Net Operating Income does not include mortgage payments, encompassing both principal and interest. Mortgage payments are categorized as “debt service” or “financing costs,” not operating expenses. Operating expenses are costs directly related to the day-to-day running and upkeep of the property, like keeping the lights on or fixing a leaky pipe.
Debt service is a cost tied to the property’s financing structure, not its physical operation. This exclusion means NOI shows a property’s performance independently of how it was purchased or leveraged. For example, two identical properties would have the same NOI, regardless of whether one was bought with cash and the other with a significant mortgage. This allows for a direct comparison of properties, abstracting away individual investor financing decisions.
Why NOI Matters
NOI is a metric for investors and lenders to evaluate a property’s financial health and investment viability. It provides insight into a property’s operational efficiency and its capacity to generate cash flow.
Investors use NOI to calculate the capitalization rate (cap rate), which helps determine a property’s value and potential return on investment. The cap rate is derived by dividing NOI by the property’s current market value or purchase price, offering a standardized measure for comparing different investment opportunities. Lenders also use NOI, particularly in metrics like the Debt Service Coverage Ratio (DSCR), to assess a borrower’s ability to cover debt obligations with the property’s income.