What Is Net Operating Income Equal To?

Net Operating Income (NOI) is a fundamental financial metric in real estate. It offers a standardized measurement of a property’s profitability, focusing on income generated from its operations before considering financing costs or income taxes.

Defining Net Operating Income

Net Operating Income (NOI) represents the income a property generates after accounting for all its direct operating expenses. It is a pre-tax and unlevered measure, reflecting the property’s financial performance independent of how it is financed or the owner’s tax situation. The basic formula for calculating NOI is Gross Operating Income minus Operating Expenses. This calculation provides insights into a property’s operational efficiency. Investors and lenders use NOI to evaluate a property’s potential cash flow and profitability.

Identifying Operating Revenues

Operating revenues are the initial component of the NOI calculation, representing the total income a property generates from its primary operations. This starts with Potential Gross Income (PGI), the maximum rental income if all units were occupied and rent collected. Adjustments for vacancy and credit losses lead to Effective Gross Income (EGI), which forms the basis for operating revenues. Common examples of these revenues include:
Base rental income
Percentage rent from retail tenants
Parking fees
Laundry machine income
Vending machine income
Amenity fees
Storage rentals

Understanding Operating Expenses

Operating expenses are the day-to-day costs incurred for running and maintaining a property, subtracted from gross operating income to determine NOI. These recurring costs include property taxes and property insurance premiums. Utilities such as electricity, gas, water, and sewer paid by the landlord are common operating expenses. Maintenance and repairs are also included. Other examples include:
Property management fees
Cleaning services
Landscaping
Pest control
Administrative costs, including professional fees

Exclusions from Net Operating Income

NOI excludes certain financial items to provide a clear picture of a property’s operational performance, independent of financing and ownership structure. Debt service, including principal and interest payments on mortgages, is excluded because NOI measures profitability before factoring in financing decisions. This allows for an “apples-to-apples” comparison of properties regardless of their debt levels.

Income taxes are also excluded from NOI, as it is a pre-tax measure reflecting property performance.

Capital expenditures (CapEx), which are significant, non-recurring investments like roof replacements or major HVAC system upgrades, are not included. These are considered investments that extend the property’s life or improve it, rather than daily operating costs. Depreciation and amortization are similarly excluded as they are non-cash accounting expenses.

The Role of Net Operating Income

Net Operating Income is a central metric in real estate analysis, providing a standardized way to assess a property’s financial performance. It allows investors to compare the profitability of different properties on an equivalent basis, irrespective of their financing arrangements or owner’s tax obligations. This comparability is useful for evaluating potential investment opportunities.

NOI is frequently used in real estate valuation, notably through the capitalization rate (cap rate) formula. The cap rate, calculated by dividing NOI by the property’s market value, helps investors determine an estimated return on investment and assess if an asking price is reasonable.

Lenders also rely on NOI to evaluate a property’s ability to cover debt service, influencing financing decisions and loan approvals. It helps investors make informed decisions about acquisitions, dispositions, and refinancing.