How to calculate your net operating income (NOI)12/14/2017 (Updated 12/20/2017)
Calculating Net Operating income is paramount in figuring out the value of commercial or multi-family residential real estate. You will need to understand how NOI works when selling or buying Duplexes, Apartment buildings, Retail properties, Office Buildings, and Industrial properties.
The experienced agent we will refer to you will calculate your property’s NOI for you but we want you to understand how it works and why it is so important!
What is NOI?
Net Operating income, or NOI is the basis of Real Estate value under the Income Capitalization Approach. It is the single most important metric that a savvy investor will want to know when looking to purchase an income producing property. Once an investor knows the NOI of a property he or she can quickly figure out it’s value by simply dividing the NOI by the market Cap Rate.
Remember, investing in Real Estate is a business, and some businesses are more profitable than others!
Some investors look for properties that may have an upside by doing some renovation in hopes to raise the rent. They may also look for ways to lower operating expenses. Both of these techniques will raise the NOI and thus the VALUE of the property!
The basic rule of thumb is: The higher the rental income and the lower the expenses, the higher the NOI.
How to Calculate NOI
Gross Operating Income (-) Gross Operating Expenses = NOI
To calculate NOI, you simply subtract your gross operating expenses from your gross operating income.
In other words, Net Operating Income is the gross operating income of the property less any operating expenses.
Pretty simple, right?
Yes, it is very simple on the surface but a lot of things must go into the formula so that you can have an accurate picture of your Net Operating income.
Calculating Gross Operating Income
The generally accepted way to calculate Gross Operating Income amongst investors is as follows:
Potential Base Rent (contract rent and vacancies marked up to market rent)
(+) Potential Reimbursables (things like utilities, tenants’ pro rata shares of property taxes, common area maintenance, etc.)
(=) Potential Rental Income
(+) Other income Subject to Occupancy (things you make money from tenants on like- laundry machines, vending machines, parking spots, etc.)
(=) Potential Rental Income Subject to Occupancy
(-) Vacancy & Credit Loss (typically you will subtract 5% from your “Potential Rental Income Subject to Occupancy” to account for vacancies, late payers, or other losses)
(=) Effective Income Subject to Occupancy
(+) Other Income NOT Subject to Occupancy (additional things you make money on whether the property is leased or not- billboards, cell phone towers, naming rights, etc.)
(=) GROSS OPERATING INCOME
As you can see, a lot goes into it!
An important thing you will note is that when calculating Net Operating Income, you make an assumption that all of your available space is rented. For vacancies, you will use a market rate rent which will be reduced by the vacancy and credit loss factor in the formula.
Our commercial agents are the best source for current market rates and will calculate your gross operating income and NOI for you. We can refer you to an expert agent now.
You can use also use our Free Rent Roll tool to help you figure out your current rent for each unit.
Another important thing to notice is that reimbursable expenses such as utilities are treated as income and then later subtracted as expenses. This is due to the fact that you would still have to pay them if you did not have a tenant so they are also subject to the vacancy and credit loss factor!
Gross Operating Expenses
These are the operating expenses that are almost universally accepted as typical operating expenses for a commercial or residential income property. Virtually all properties will be subject to these expenses:
- Property taxes
- Utility bills
- Rubbish collection
- Janitorial services
- Landscaping costs
- Pest control
- Fire safety (fire extinguisher, alarm tests, etc.)
- Repairs & Maintenance
- Management fees
- Allowances for Tenant Improvement
Putting it into a Pro Forma and Using NOI to Determine Real Estate Value
You can figure out your current NOI yourself by using the tips we outlined above. But when it comes time to sell your commercial or residential income property, the agent we refer you to will create something called a pro forma which will list all of your income and expenses on one sheet.
A pro forma will also show a 5 year projection of NOI based on your rent roll and expenses. Your agent will use this information to determine an accurate sales price by using the income valuation approach.
He or she will also provide the pro forma to potential buyers for them to verify and study as part of the process of selling your commercial property.
Use Kozeee to find a commercial or multi-family specialist experienced in selling your type of property now. We will refer you to a licensed and qualified agent anywhere in the USA.