Net Operating Income in Commercial Real Estate
Net operating income (NOI) is a valuing approach used by real estate experts to calculate the exact value of their revenue-producing assets. A property may produce revenue via utilities such as parking garages, vending machines, and laundry facilities in addition to rental revenues.
NOI is a frequently used metric to evaluate a property’s performance. The computation comprises deducting all property-related operational costs from any income the property has produced. A property is more lucrative when its revenues are higher and its expenses are lower.
The costs of managing and maintaining the facility are included in operating expenses, which include insurance premiums, legal fees, utilities, property taxes, maintenance charges, and housekeeping fees. Capital expenses, such as the cost of a new air-conditioning system for the entire building, are not factored in.
What is Net Operating Income (NOI)?
Net operating income (NOI) is a metric used to assess the viability of income-producing real estate assets. NOI is the sum of all commercial property revenue minus all required operational expenses. NOI is a pre-tax figure on a property’s income and cash flow sheet and eliminates loan principal and interest, capital spending, depreciation, and amortization.
In other industries, this concept is referred to as “EBIT,” which means “earnings before interest and taxes.”
How to Calculate Net Operating Income
Subtract operating expenses from revenue received by a property to determine net operating income. Rental money, parking, service, vending machines, laundry machines, and so on contribute to commercial real estate revenue.
All expenditures related to running the property are included in the operating expenses. These consist of the cost of property management and upkeep, repairs, and utilities.
Net operating income= RR−OE
RR= real estate revenue
OE= operating expenses
Let’s use the profile of a specific condo complex that a landlord was renting out as an illustration.
- Rental income: $20,000
- Parking fees: $5,000
- Laundry machines: $1,000
Total Revenues = $26,000
Let’s now assume that the condo building’s operational costs are as follows:
Property management fees: $1,000
Property taxes: $5,000
Repair and maintenance: $3,000
Total Operating Expenses = $10,000
In this case, the net operating income (NOI) would be $26,000-$10,000= $16,000.
Factors That Affect Net Operating Income
Several factors influence net operating income. Some of these factors include insurance, property tax, property management fees, the condition of the property, and maintenance. The generated revenue as well affects it. These factors determine how high or low the NOI would be.
Uses of Net Operating Income
- Net operating income is used to determine the capitalization rate of a property, also known as the return on investment (ROI) in real estate.
- Net operating income can be used to determine the loss to lease and tenant reimbursement.
- Net operating income can help asses how well the property is managed.
- Net operating income can be used to determine a property’s performance.
- Net operating income is frequently used to approve commercial loans for real estate investors.
Pros and Cons of Investing in a Property with High or Low Net Operating Income
Although it’s a great indicator to consider when deciding whether or not to make a real estate investment, net operating income could be a better metric. Here are some of the pros and cons.
- The real estate NOI formula is helpful for investors to understand what to anticipate in terms of recurring income.
- Lenders might use the real estate NOI value to determine whether a property is a risky investment.
- The NOI will suffer if the predicted rents turn out to be incorrect.
- Since it relies on how the property is handled, the NOI might fluctuate greatly.
How to Improve Your Commercial Property’s Net Operating Income
Examining how your properties are currently used and maintained is the first step in increasing your property’s Net Operating Income. Superior quality properties not only require less upkeep, particularly expensive emergency maintenance, but they also allow you to charge more per square foot.
Start by speaking with your building operators and facilities staff to understand how things are currently operating. You should be able to receive primary data on the maintenance work they perform every day if you are using a facility management system.
Assessing the amount of preventive maintenance being performed is one thing to consider when planning the maintenance of your facilities. Although it does involve a little initial investment, preventative maintenance enables your teams to keep ahead of problems and increase the lifespan of facility assets, both of which result in long-term cost savings.
Deferred maintenance is an additional area where, with modest initial inputs, your facilities’ quality and NOI can be significantly increased. Your teams likely have a lengthy list of pending maintenance that they have yet to be able to complete because of financial constraints.
Even though these chores are inexpensive on their own, as the list grows, more repairs and failures occur, raising your maintenance costs.
What capital improvements your buildings require should be your last point of consideration when trying to raise their quality. Although these upgrades or repairs are expensive one-time charges, the long-term cost savings can be significant and don’t affect your net operating income estimate.
Your utility expenses can increase by hundreds of dollars a month when a building asset, such as the HVAC system or a water heater, is old and in bad shape. To spend your funds properly and obtain the most for your money, you must know which capital investments are impending and which carry the most risk.
Examples of Properties with High or Low Net Operating Income
A net operating loss (NOL) happens when operating costs exceed revenues and the sum is negative. Let’s say you are the property owner with annual revenue of $120,000 and running expenses of $80,000. In this case, the resulting Net Operating Income will be $40,000 ($120,000-$80,000).
Creditors and commercial lenders rely on NOI to assess the property’s capacity to produce revenue even more than they do on an investor’s credit history when making decisions.
Another example, the total income would be roughly $12,000 if the gross operating income was $10,000, producing an extra $2,000 in miscellaneous income. The net operating income would be approximately $8,000 if running costs were around $4,000. However, if there were several vacancies and the total income was only about $4,000 while the fees were $10,000, the NOI would be negative $6,000 instead.
Net operating income (NOI) is a frequently used metric to evaluate a property’s performance. The computation comprises deducting all property-related operational costs from any income the property has produced. The property is more lucrative when its revenues are higher and its expenses are lower.
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