Net Operating Income or NOI is a basic calculation used in real estate and rental property investment to help an investor or property buyer determine the potential profitability of their property investment purchase.
The NOI is used to determine whether a real estate property or investment purchase will be able to operate at a profitable return, after subtracting all the necessary operating expenses.
The most basic usage of NOI is to examine how underlying cash flows of an investment property will be affected before subtracting all taxes, and financial operating costs.
Before an investor either purchases an investment property or puts it on the market, the NOI will help them determine the property valuation, as a way to understand the value they need to add to the property.
To calculate the Net Operating Income, investors use the following formula:
NOI = Gross Operating Income + Other Income – Operating Expenses
Gross Operating Income = Potential Rental Income – Vacancy Rates
The Potential Rental Income is the amount you’ll make if the property was 100% rented for 100% of the time. To determine if this is possible, or what the current lease percentage per year is, it’s possible to ask previous tenants, owners, and the current tenants that reside there.
An investment property, with two-unit apartments, is currently available, with a monthly rent of $1,800. If both units were to be occupied for a full year, the Potential Rental Income (PRI) would be $43,200 per year.
There’s a small coin laundry machine that makes about $650 per year.
Currently, the vacancy losses are about 7% which is equal to PRI x 0.7, or $3,024 per year.
Gross Operating Income = $43,200 – $3,024 = $40,176.
The current balance sheet indicates that operating expenses are about $9,400 per year.
Net Operating Income = $40,176 (GOI) + $650 (other income) – $9,400 (Operating Expenses) = $31,426 NOI annually.
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