Net Operating Income is the most critical figure in analyzing an income property for acquisition.
Net operating income is a measure of a real estate investment’s profitability. To calculate net operating income or NOI, we take the property’s revenue and subtract all reasonable operating expenses.
Investors always talk about purchase price and cap rate when it comes to income properties. However, those two figures come from Net Operating Income. To calculate a cap rate for property, divide NOI by purchase price. To calculate purchase price, divide NOI by a cap rate. In both calculations is done by creating quasi figures for both cap rate and purchase price. Only factual data is NOI in the computation.
It is even worse for the purchase price. The purchase is usually set by the owner with consultation from his/her broker. We always recommend you do your due diligence and only purchase a property when all the numbers work in your favor. You set your own price.
Net operating income is a stronger indicator as to whether a real-estate investment is profitable or has the potential to be profitable. NOI is reported on income and cash flow statements and examines the cash flows of an investment property before factors like financing costs and taxes are taken into the equation.
If a property’s total revenue over a given period is $200,000, and its operating expenses equal $100,000, then its net operating income is $100,000. Ideally, a property’s net operating income should be positive. If the total is negative, it becomes a net operating loss.
There are several ways for property to generate revenue. These include:
Similarly, numerous operating expenses go into running a property. These include:
Net operating income is a reliable measure of a property’s ability to generate income. The NOI calculation excludes figures such as income taxes or financing costs. Instead, it shows how much revenue a given property can produce on its own.
Net operating income is considered an accurate measure of a property’s potential because it is less subject to manipulation than other figures. NOI can typically only be increased by raising rents, increasing the cost to use on-site facilities like laundry and parking, or finding lower-cost options for maintenance and repairs.
Net operating income is essential in helping investors determine a property’s capitalization rate, which is the rate of return on an investment property based on the income that it’s expected to generate. As such, NOI can help an investor compare different properties to see which has the most potential. It can also be useful for an investor who owns several properties and is looking to unload the one whose operating costs leave the least amount of room for profit.
Now you know, every dollar increase in NOI will affect the value of building by multiple folds. Below is an example of how the potential can be realized:
Is it going to be easy to achieve this? Probably not unless you are a professional who understands the complexity of claiming this potential. You must plan this before you acquired the property. Plan your investment strategy. Execute your plan. That is why working with a professional is a must, and we are here to help.
