Net operating income is used for the purpose of analyzing the income generated from real estate investments.
NOI can be found on cash flow statements and property income. If the end result is negative, then it is called net operating income loss. It can be increased by hiking the rental payment or by decreasing operating expenses. Operating expenses are insurance, property management fees, utilities, property taxes and repairs.
NOI is non-taxable income and it helps in calculating cap rate, ratios like debt coverage ratio (DCR) which tells whether the property income includes debt and operating expenses or not. It measures the ability of income generation of a property. Lease analysis is the initial step to analyze how income is generated; it helps out the investors as it indicates both who has paid as well as the source.
DC Fawcett Reviews further explains how to calculate NOI.
Potential rental income- vacancy and credit loss = effective rental income
Effective rental income +other income =gross operating income
Net operating income is positive when operating income exceeds gross operating income.
Lets breakdown the formula of real estate
- Potential rental income is also known as PRI is cumulative of rental payments if occupied entirely. If not, market based rents is used.
- Vacancy and credit loss means income lost due to renters vacating the property or when they don’t pay their rent every month.
- Effective rental income is the amount that the seller /owner gets in hand
- Other income refers to laundry, parking etc.
- Gross operating income is sum of all income generated from a property.
- Operating expenses include personal and property taxes, insurance, management fee etc.
Net operating income doesn’t include the following expenses
- Debt: financing powers remains with owner /investor.
- Depreciation: accounting entry alone so excluded
- Home improvements: These changes are done according to tenant’s wish. So charges are not taken while calculating NOI.
- Commission is paid to brokers and agents
- Amount is allocated for repair and renovation work. Those funds are excluded.
- Capital expenses are also part of repair work; it may happen in irregular interval.
NOI is used to
- Measure the profit of an investment
- Calculate underlying cash flows
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You can take help of the real estate professionals, tax advisors to calculate NOI for your property.
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