Net Operating Income (NOI): Formula and Calculation with Examples
Analysing investment opportunities and asset performance helps you in making informed investment decisions to maximise your returns. There are several metrics that provide the required information about the benefits that the asset may have. One such important performance indicator that investors should know about is how to calculate Net Operating Income( NOI) to assess the returns on the asset in which they intend to invest.
While NOI is a popular metric in company finances, did you know that NOI is also a great indicator of the profitability of a real estate investment? NOI calculates the commercial property’s operating income to give us information about the ability of the asset to generate income. Let’s deep-dive.
What is Net Operating Income (NOI)?
Net operating income or NOI is a calculation that investors use to determine the profit potential and financial health of their investment in commercial real estate. NOI is important because it assimilates all of the income and expenses for the property into a single calculation.
It is the income generated by the asset after excluding the operating costs. The main purpose of this formula is to provide the investors with information about the cash flow a property generates.
Formula to Calculate Net Operating Income
Net operating income gives the revenue and total profit of a property after subtracting necessary operating expenses. Once you have determined what expenses to include, you can calculate NOI by using the simple formula mentioned below:
Net operating income (NOI) = (Gross Operating Income + Other Income) – Operating Expenses
- Gross operating income would include all rental revenue.
- Other sources of income would be:
- Parking charges
- Vending machine earnings
- Revenue from laundry machines
- Storage fees, gym fees, and so on.
- Operating expenses would include:
- Property management fees
- Marketing costs
- Taxes on real estate
- Repairs
- Maintenance
- Insurance
Also Read: How To Pay Income Tax Online: 4 Advantages Of Income Tax E Payment
How to Calculate NOI?
While calculating net operating income you need to know about gross operating income, other income and operating expenses.
1. Gross Operating Income
To calculate NOI to determine profitability of a property, you need to calculate your Gross Operating Income (GOI). Gross operating income includes all income possibilities and fluctuations that might occur. It is not just the value of your property. You can calculate gross operating income by using the following formula:
Gross Operating Income = Potential Rental Income – Vacancy Rates
- Potential rental income: Potential rental income (PRI) is the revenue you’d create if the property was completely leased all of the time.
- Vacancy rates: As your property won’t be leased 100% of the time that is why gross operating income incorporates vacancy rate and credit losses against potential rental income. Use comparable property vacancy rates or historical accounting to get a better idea of the vacancy percentage you should use in your calculations.
2. Other Income
NOI includes any additional or other income generated by a property. A rental property can earn money other than rents in a variety of ways, for instance, additional income could be generated by installing a vending machine, laundry facilities or parking.
Example of Net Operating Income
Here’s an example of how to calculate NOI:
Suppose you are evaluating a property for the purpose of investment with four units. Each unit in the property rents for Rs 10,000 per month.
From here, we derive the potential rental income= Rs 480,000 per year.
Suppose there is a vending machine in the basement of the property making an additional Rs 10,000 per year, and vacancy losses are 10% per year or Rs 48,000.
According to the formula,
Gross Operating Income = Potential Rental Income – Vacancy Rates
Gross Operating Income = Rs 432,000.
Let’s assume that according to the current owner’s accounting, operating expenses are Rs 50,000 per year.
Net operating income (NOI) = (Gross Operating Income + Other Income) – Operating Expenses
Net operating income (NOI) = ( Rs 432,000+ Rs 10,000) – Rs 50,000
Net operating income = Rs 392,000 annually
Now, the investor can make an informed decision about the investment based on whether this meets their investment goals and if the purchase price makes sense to them.
How NOI is Used to Determine Cap Rate?
The capitalization rate also called cap rate is a very common term that real estate investors should be familiar with. It is used to describe the rate of return on a property based on its net operating income(NOI).
It is a return metric used to calculate the potential return on investment or capital payback. Cap Rate is calculated by dividing Net Operating Income (NOI) by the asset’s current market value.
Capitalization rate = net operating income/current market value of asset
What are the Differences between Operating Income and Net Income?
Let’s understand the difference between operating income and net income:
| Operating Income | Net Income |
| Operating income is a company’s profit after subtracting operating expenses, which are the costs of daily operations | Profits or earnings of a firm are referred to as net income |
| Taxes are not considered in operating income | Net income is derived after tax considerations |
| It is used to calculate return on capital employed | Used to calculate ratios such as return on equity, return on assets, etc. |
| Operating income is determined by deducting operating expenses from gross profit | Net income is computed by subtracting depreciation, interest, taxes, and other expenditures from operating income |
Also Read: Section 35AD of the Income Tax Act: Eligibility, Specified Business & Deductions
Final Word
Net operating income is a calculation that assists investors in determining the cash flow projections of a property, which in turn offers information on the property’s profit potential and valuation. It is commonly shown on an income and cash flow statement and is calculated by subtracting all operational expenses from gross sales.
Note that net operating income is distinct from net income. One-time profits and losses, interest, and taxes can occasionally mislead net income, providing a different picture of the business than it is in reality.
As a result, while analysing net income is significant, reviewing net operating income is equally crucial because it consistently compares from one quarter to the next.
FAQs on Net Operating Income
Ans. NOI is a pre-tax figure that appears on a property’s income and cash flow statement and excludes loan principal and interest, capital expenditures, depreciation, and amortisation.
Ans. Payments for commodities, sub-suppliers, labour, and overhead to handle these activities comprise operating costs. If you can’t raise sales, you can’t increase operational revenue. The only method to boost net operating income is to lower operational expenses.
Ans. Operating income is defined as revenue minus any operating expenses, whereas net income is defined as operating income minus any other non-operating expenses such as interest and taxes. Selling, general and administrative expenses (SG&A), and depreciation and amortisation are all part of operating income.
Ans. Operating profit assists in separating a company’s profit by displaying earnings from operations. Net income is significant because it includes all revenues and expenses and is used to compute earnings per share.
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