Net Operating Income
What doe NOI mean. Why is it so important in buying or selling commercial real estate in Toronto
Understanding Net Operating Income (NOI)
Net operating income is a valuation method used by real estate professionals to determine the precise value of their income-producing properties. To calculate NOI, the property’s operating expenses must be subtracted from the income a property produces.
In addition to rental income, a property might also generate revenue from amenities such as parking structures, vending machines, and laundry facilities. Operating expenses include the costs of running and maintaining the building, including insurance premiums, legal fees, utilities, property taxes, repair costs, and janitorial fees. Capital expenditures, such as costs for a new air-conditioning system for the entire building, are not included in the calculation.
NOI helps real estate investors determine the capitalization rate, which in turn helps them calculate a property’s value, thus allowing them to compare different properties they may be considering buying or selling.
For financed properties, NOI is also used in the debt coverage ratio (DCR), which tells lenders and investors whether a property’s income covers its operating expenses and debt payments. NOI is also used to calculate the net income multiplier, cash return on investment, and total return on investment.
How to Calculate Net Operating Income (NOI)
To calculate net operating income, subtract operating expenses from the revenue generated by a property. Revenue from real estate includes rental income, parking fees, service changes, vending machines, laundry machines, and so on.
Operating expenses include all of the costs associated with operating the property. These include property management fees, insurance, utilities, property taxes, repairs, and maintenance.
Net Operating Income (NOI) Formula
As an example, let’s assume the below information was the profile of a particular condo building that an owner was renting out.
- Rental income: $20,000
- Parking fees: $5,000
- Laundry machines: $1,000
Total Revenues = $26,000
Now, let’s assume the operating expenses of the condo building are as follows:
- Property management fees: $1,000
- Property taxes: $5,000
- Repair and maintenance: $3,000
- Insurance: $1,000
Total Operating Expenses = $10,000
The net operating income (NOI) in this example would be $26,000 – $10,000 = $16,000.
Example of Net Operating Income (NOI)
Let us assume that you own a property that annually pulls in $120,000 in revenues and incurs $80,000 in operating expenses. In this circumstance, it will have a resulting NOI of $40,000 ($120,000 – $80,000). If the total is negative, where operating expenses are higher than revenues, the result is called a net operating loss (NOL).
Creditors and commercial lenders rely heavily on NOI to determine the income generation potential of the property to be mortgaged, even more than they factor an investor’s credit history into their decisions. Simply put: this metric helps lenders fundamentally assess the initial value of the property by forecasting its cash flows.
NOI is used to determine the capitalization rate of a property, also known as the return on investment (ROI) in real estate. It divides NOI by the purchase price.
If a property is deemed profitable, the lenders also use this figure to determine the size of the loan they’re willing to make. On the other hand, if the property shows a net operating loss, lenders are likely to reject the borrower’s mortgage application, outright.
Property owners can manipulate their operating expenses by deferring certain expenses while accelerating others. NOI can also be increased by raising rents and other fees, while simultaneously decreasing reasonably necessary operating expenses.
As an example of the latter, consider a scenario where an apartment owner waives a tenant’s yearly $12,000 rent, in exchange for that renter acting as a property manager. If the apartment owner would normally pay a building manager a $30,000 salary, they may consequently subtract the “reasonably necessary” cost of $30,000 from revenue, rather than the actual cost of $12,000.
Net Operating Income (NOI) Formula FAQs
What is the formula for calculating NOI?
The formula for calculating NOI is as follows:
- NOI = real estate revenue – operating expenses
How do you calculate net operating income (NOI) before tax?
NOI is a before-tax calculation in that it does not take tax into consideration.
What is the difference between net income and net operating income (NOI)?
Net operating income is revenue less all operating expenses while net income is revenue less all expenses, including operating expenses and non-operating expenses, such as taxes.
What is a good net operating income (NOI) percentage?
NOI is not a percentage but rather a number that takes into consideration the revenues and expenses of a property. It can be compared to the entire value of the property if that property had been paid fully in cash. In this case, the higher the net operating income to property price percentage, the better.
The Bottom Line
Net operating income (NOI) is a commonly used figure to assess the profitability of a property. The calculation involves subtracting all operating expenses on the property from all the revenue generated from the property. The higher the revenues and the smaller the expenses, the more profitable a property is. This tells the owner if the income generated from owning and maintaining the property is worth the cost.
If you have any questions on NOI when buying a Toronto Commercial Real Estate Property.
Or a Toronto Investment property. Please call Allen Mayer, Toronto Commercial Real Estate Broker.