Net Operating Income (NOI): Definition And Formula

There are a handful of tools any real estate investor may need in their tool belt: solid knowledge of their preferred real estate market, the ability to estimate remodel costs and a firm grasp on basic financial concepts. One of the most important calculations for real estate investors is knowing how to correctly calculate net operating income (NOI).

This powerful calculation enables real estate investors to make financial decisions at-a-glance. Let’s take a look at what NOI means in real estate and how to calculate it.

What Is Net Operating Income In Real Estate?

Net operating income (NOI) is a formula that real estate professionals often use to quickly calculate the profitability of a particular investment. NOI determines the revenue and profitability of investment properties after subtracting necessary operating costs.

The formula works by succinctly considering all income a property makes minus all of the general expenses. For example, a property may earn money from tenant rental payments and a coin laundry machine. Operating expenses include home maintenance fees, homeowners insurance and property taxes.

NOI takes into consideration all of the necessary income and expenditures for every rental property into one calculation.

Net Operating Income Formula

The formula for NOI is as follows:

Net Operating Income = (Gross Operating Income + Other Income) − Operating Expenses

Below, we’ll walk through all the numbers to include in your formula and how to calculate NOI.

Gross Income Vs. Net Income

When calculating NOI, you’ll need to be able to tell the difference between your gross profit and net profit, especially as we break down the formulas below. Here are two things to remember: Your gross income is the money you make from the real estate investment(s), while your net income is the money you take home.

Gross Operating Income (GOI)

To accurately calculate NOI, first you need to calculate your gross operating income (GOI). The formula for GOI is as follows:

Gross Operating Income = Potential Rental Income − Vacancy Rates

It’s easy to fall into the trap of assuming that your gross income is simply what the property is worth. This isn’t necessarily true. Gross operating income mathematically accounts for possibilities and fluctuations in a property’s income.

Here’s a breakdown of the factors that are included in the gross operating income formula.

Potential Rental Income

Potential rental income is how much you’d make if the property was 100% leased, 100% of the time. This is the number that’s easy to stumble on because investors often think in terms of the “best case scenario.”

Vacancy And Credit Losses

It would be great if a property was 100% leased, but this isn’t likely each year. This is why the gross operating income formula factors in vacancy and credit losses against potential rental income.

When evaluating a potential investment, use vacancy rates from comparable properties in the area or ask the current owner for the property’s historical accounting record. This can give you a better idea of the vacancy percentage you should use to come up with your calculations.

How To Calculate NOI

Now that you understand how to calculate your gross operating income, let’s go over some of the other factors included in the NOI formula – your additional income and operating expenses.

Other Income

Remember, NOI takes into account all income, which is your gross operating income plus any additional income a property makes. A property can make money outside of rental income in a variety of ways. For instance, maybe the property has vending machines, a parking lot that requires an additional monthly fee or a coin-operated laundry machine.

A property may make additional income, but not always. If your rental property doesn’t make other income, you don’t have to add another value to your GOI in the net operating income formula.

Operating Expenses

After you know the amount of your gross income, you’ll need to consider all your operating expenses – or what it actually costs to own the property. Operating expenses you’ll want to include in your calculations are:

• Property taxes
• Homeowners insurance
• Maintenance and repair costs
• Property management fees
• Accounting and attorney fees
• Marketing costs

Example NOI Calculation

NOI is often calculated on an annual basis. Let’s take a look at an example of how to calculate your NOI.

Say you’re evaluating a potential investment property. It’s a small, four-unit apartment complex. Each unit rents for $1,500 per month, making the potential rental income $72,000 per year. The coin laundry in the basement of the property makes about $1,000 annually.

Historical accounting records show that the property’s vacancy losses are around 10% ($72,000 × .10), or $7,200 per year. This brings the gross operating income to $64,800 ($72,000 − $7,200). Based on the current owner’s accounting, operating expenses are $15,000 each year.

As a refresher, the formula for NOI is:

Net Operating Income = (Gross Operating Income + Other Income) − Operating Expenses

The formula for this example is:

NOI = ($64,800 + $1,000) − $15,000

NOI = $50,800 annually

How Investors Can Use NOI Calculations

The investor in the above example will make a net operating income of about $50,800 a year. Based on this NOI calculation, an investor can then:

• Use this number to compare the income of this investment to other properties.
• Determine if the investment property earns enough to cover any mortgage loans.
• Figure out the cap rate, which is the total rate of your potential return on investment (ROI).
• Calculate a property’s worth and determine how much to offer for the purchase.

How NOI Is Used To Determine Cap Rate

If you�