Net Operating Income "NOI"

Understanding Net Operating Income "NOI"

NOI is the driving number behind the valuation of commercial real estate. And it's important to understand where that number comes from, how it's used, and the significance that it has over our investments. 

Net operating income is exactly that. It's the net income from operations after all of the operating expenses have been paid. So if this is our total revenue, and then we have our expenses, this is our NOI.

NOI / Value = Cap Rate

Now, NOI can be used for a lot of things. For instance, if we take our NOI and we divide it by our purchase price, or value, that gives us our cap rate. 

NOI / Debt Service = Debt Service Coverage Ratio

NOI can also be used to calculate if we take our annual debt service or NOI divided by our annual debt service, that gives us our debt service coverage ratio.

NOI - Debt Service = Net Cash Flow

And finally, since NOI is what we use to pay our debt service, if we take the NOI minus the debt service, that gives us our net cashflow which we can use to calculate our Cash-on-Cash return. 

Steps to Calculating NOI

Here are the steps to calculating the NOI on a property. 

Scheduled Gross Income (SGI)

First, we need to know what our scheduled rents are. Scheduled rents are the rents that would be collected on the property if all spaces or units were completely full 100% of the year. Effectively, it's the rent roll, or the lease schedule, times 12 months for the total annual rents. 

Vacancy

From there, most of the time we have an assumed vacancy. 

Vacancy can be variable depending on the market, however, most of the time we must assume that some vacancy is going to happen. And the industry standard for at least multi-family vacancy or most investment properties is 5%. 

Other Income

From there, we also get other income. Other income can be laundry income, application fees or credit check fees, late fees, non-sufficient funds, anything that isn't part of the rent roll, but is still income to the property. 

Effective Gross Income (EGI)

And if we add these, obviously this is a negative, so we would subtract that, and add that, we get our effective gross income. Effective gross income, or EGI, is basically our net revenue number. 

Operating Expenses

From there, we need to take out operating expenses. Important note is that operating expenses do not include debt service or payments to the owner. But they are expenses that are related strictly to the operation of the property. 

So for example, operating expenses would include things like real estate taxes, hazard insurance, property management, utilities, repairs and maintenance, anything that is necessary to operate the property, those would be our total expenses. 

Effective Gross Income - Operating Expenses = Net Operating Income

And then if we take our effective gross income minus our total operating expenses, we get our NOI.