What is NOI in Real Estate?

As a real estate agent, you’ll need a wide variety of tools under your belt to successfully guide your clients through a seamless transactional experience. One of those tools is having a good understanding of net operating income (NOI), a tool used to calculate how much money a real estate property generates each year.  

So, when it comes to evaluating real estate investments, NOI is your trusty compass for evaluating if a property is a financially smart investment. Below, we’ll break down the basics of NOI so you can help your clients make good decisions about their property investments. 

The basic definition of NOI. 

Net operating income is the total revenue generated by a property from all sources, such as rental income and additional income (e.g., parking fees or laundry facilities), minus all operating expenses required to run the property. This excludes mortgage payments and income taxes.  

Net Operating Income (NOI) is a financial metric used to find out the profitability of income-generating properties. 

The formula for calculating NOI is: 

Net Operating Income (NOI) = Total Revenue - Total Operating Expenses 

Why is NOI so important for real estate evaluation? 

NOI gives you a clear idea of how much money a property is actually making – that means no hidden surprises! It also gives you the opportunity to compare different properties to determine which is the best choice. A property with a higher NOI generally means better performance and a stronger financial return. 

Since NOI doesn’t include mortgage payments, you can focus on the property’s performance before financing it. You can also analyze NOI data to forecast future income and help your client plan for a successful investment journey. 

Understanding net operating income (NOI). 

In its simplest form, the formula for calculating NOI is: Total Revenue - Operating Expenses. 

To calculate NOI accurately, you need to consider two main components: total revenue and operating expenses. Let's break them down: 

• Total Revenue.  This includes all the income generated by the property, primarily through rental payments from tenants. It is essential to factor in other sources of income, such as parking fees, laundry facilities, or any additional services offered to tenants. 

• Operating Expenses.  These are the various costs associated with operating and maintaining the property. They typically include property taxes, insurance, property management fees, utilities, maintenance and repairs, marketing expenses, and any other necessary expenditures directly related to running the property. 

It is important to note that the NOI does not include mortgage payments or any financing-related costs. The purpose of excluding this debt service is to provide a clear picture of the property's profitability before accounting for the effects of financing. 

How to calculate the NOI on a property. 

You might be thinking: I’m starting to get it, but how do I actually calculate the NOI on a real property? The method is more straightforward than you might think. 

Step 1: Gather Income 

Add up all the income generated by the property in a given period (usually a year). This includes rent from tenants and any additional income sources like parking fees, laundry facilities, or vending machines. 

 

Step 2: Identify Operating Expenses 

Make a list of all the expenses required to operate the property. This includes property management fees, maintenance costs, property taxes, insurance, utilities, and any other expenses directly related to running the property. 

 

Step 3: Calculate NOI 

Once you have the total income and total operating expenses, subtract the operating expenses from the total income. The result is the net operating income of the property. 

And that's it! This metric helps provide a clear picture of how much money the property is making after accounting for the costs of running it. NOI is essential for real estate evaluation and helps investors assess the property's financial performance and potential for generating income. 

Factors affecting NOI. 

There are many key factors that can affect your NOI.  

• Occupancy Rate.  How many units are filled with happy tenants? A higher occupancy rate means more rental income and a healthier NOI. 

• Rental Income.  Setting the right rent is crucial. Adjusting rental rates can directly affect a property's overall revenue and, in turn, the NOI. 

• Operating Expenses.  Managing costs like maintenance, utilities, and management fees matters. By keeping these in check, people can improve their bottom line. 

• Property Taxes.  Nobody likes surprises when it comes to taxes. Being aware of a property's tax liabilities helps preserve an NOI. 

• Market Trends.  Real estate markets are like roller coasters. Stay informed about demand and supply shifts, which can impact rental rates and NOI. 

• Location. Where a property is located plays a significant role in determining rental rates and, ultimately, the NOI. 

• Property Size and Type.  Bigger isn't always better. Understand how the size and type of property affect both revenue potential and operating costs. 

• Capital Investments.  Making smart improvements can boost a property's value and attract higher-paying tenants, ultimately elevating the NOI. 

 

Example of NOI. 

Let's calculate the net operating income for a rental property that a hypothetical client is considering. Assume they are interested in a small apartment building with the following financial information for a year: 

• Total Rental Income: $120,000 (includes all rent collected throughout the year) 

• Operating Expenses: $40,000 (includes property taxes, insurance, maintenance, utilities, and management fees.) 

• Vacancy and Credit Losses: $8,000 (total expected loss of income due to vacant units or defaults.) 

 

Now, let's calculate the Net Operating Income (NOI) using the formula: 

Net Operating Income (NOI) = Total Rental Income - Operating Expenses - Vacancy and Credit Losses 

NOI = $120,000 - $40,000 - $8,000 

NOI = $72,000 

This means that after accounting for all the operating expenses and potential losses, the property generated a net income of $72,000 over the year.  

Advantages of evaluating investments with NOI.  

• It’s better than cap rate and cash-on-cash return 

You may be familiar with other evaluation metrics, such as cap rate and cash-on-cash return. While these are useful, NOI will give you a more comprehensive view. Cap rate focuses on the property's value, while cash on cash return considers financing. NOI, on the other hand, goes beyond both – it shows the raw profitability before factoring in financing. 

• The ability to measure profitability and growth potential 

NOI tells you if your investment is truly profitable. It helps you see the potential for growth and assess the property's long-term performance. 

• You can compare properties to help your clients make the best financial decisions 

With NOI in your toolkit, you can compare different properties apples-to-apples. Higher NOI generally means better performance and more promising returns. 

 
NOI: an indispensable real estate tool 

Net Operating Income (NOI) is a useful tool for anyone involved in the world of real estate. By understanding NOI and utilizing it to evaluate property investments, real estate agents and their investor clients gain a powerful advantage in making informed decisions. 

If you want to better understand how NOI and other real estate tools can help you help your clients, enroll in one of our continuing education courses today!