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What is Net Operating Income in Real Estate: NOI Formula & More

Matt Carrigan

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Thoughtful investment decisions call for thorough, diligent screenings to ensure that the deal pencils out. Naturally, the profit a property or portfolio generates is top of mind for institutional investors, particularly for long-term acquisitions. Among others like IRR and cap rates, one of the most critical metrics investors use to gauge the profitability of a deal is net operating income. 

Read on to learn more about what net operating income is, how to calculate it, and how institutional investors rely on it to screen and underwrite deals.

What Is Net Operating Income [NOI Meaning & Definition]

Net operating income (NOI) is a real estate valuation method that measures the profitability of a revenue-generating real estate property.

NOI is calculated by subtracting all operating expenses a property incurs from the revenue it generates. This metric doesn’t take into account the costs of loan payments, capital expenditures, depreciation, amortization, or taxes on income. The NOI of a real estate property is typically included on its cash flow and income statements. 

What does NOI mean in real estate 

NOI is a metric that helps real estate investors project the income a given property will generate, and consequently, measure its value. Investors will calculate the net operating income to analyze if the costs of owning and operating that property are worthwhile based on the returns. 

While net operating income can help investors understand how much profit a potential deal can bring in, it’s hardly the only important metric used in a deal analysis. Often, deal teams will leverage a property’s NOI to arrive at other key metrics, such as the internal rate of return. NOI is rarely the sole basis for investment decisions.  

The Net Operating Income Approach 

While net operating income provides an indication of a property’s profitability, it does not offer a complete picture of the property’s value relative to market trends or risks. NOI also doesn’t take financing costs and taxes into account, instead assuming an all-cash purchase.

Rather than a variable model that factors in year-to-year changes, NOI assumes that revenue and operating costs will remain constant, which is unlikely to be the case. To account for annual fluctuations, some investors may choose to defer or accelerate certain expenses or income. 

Net operating income is most valuable as a comparative metric, in concert with other metrics like cap rates and yield on cost. This holistic perspective provides investors with the data and information they need to determine whether or not a deal aligns with their investment strategy.

NOI Formula: How to Calculate Net Operating Income

The formula for net operating income is straightforward. To calculate NOI, simply subtract a property’s operating expenses from its total revenue:

Net Operating Income = Revenue – Operating Expenses 

As an example, let’s assume an investor is considering purchasing a multifamily building.

While the bulk of the property’s revenue will come from rents, there are other income streams to consider, such as parking fees, laundry and more:

  • Rental income: $5,000,000
  • Parking fees: $250,000
  • Laundry machines: $50,000

Based on these assumptions, the building would generate a total of $5,300,000 annually.

Now, let’s assume the building’s operating expenses are as follows:

  • Property management fees: $500,000
  • Property taxes: $500,000
  • Repair and maintenance: $250,000
  • Insurance: $250,000

Combined, these costs equal $1,500,000.

Lastly, we can determine the NOI by subtracting the operating costs from the total revenue:

$5,300,000-$1,500,000=$3,800,000

In this case, the net operating income would be $3,800,000. 

Analyzing NOI as a Commercial Real Estate Investor 

Now that the formula for calculating NOI is clear, let’s consider how an investor might use NOI to evaluate and compare deals.

ValuesDeal #1Deal #2Deal #3
Total revenue$1,150,000$2,850,000$1,900,000
Total operating expenses$300,000$2,100,000$900,000
Net operating income $850,000$750,000$1,100,000
Purchase price$10,000,000$10,000,000$10,000,000
Cap rate8.5%7.5%10%

In this example, Deal #3 offers the highest NOI. At a 10% cap rate, though, it may present more risk than the investor is seeking.

Deal #2 carries the lowest cap rate, meaning it will provide the most stable revenue of all three deals. For core investors seeking low-risk assets, this may be the most lucrative opportunity.

Finally, deal #1 sits between the two, with a 8.5% cap rate.  

While none of these deals is the best, each may be appealing to an investor with a different risk profile.

Analyzing NOI Alongside Other Key Deal Metrics

From NOI to cash flow models and beyond, centralizing relevant deal information in one source of truth–together with historical data– provides the clear visibility investors need to make holistic, strategic investment decisions.
Download our white paper, Real Estate’s Tech Boom: Why It’s Time For A Deal Management Solution, to learn more about why deal management software has become the new gold standard for systematizing data-driven decision making.

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Matt Carrigan

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