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Net Operating Income in Commercial Real Estate
Net operating income is a metric that measures the profitability of an income producing asset based on the income earned minus all operating expenses.
What is Net Operating Income?
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Net operating income, or NOI, is one of the most important — and straightforward — calculations to determine the profitability of a commercial real estate investment. To calculate NOI, simply subtract an asset’s operating expenses from its revenue.
Calculating NOI
Let’s use an imaginary 60,000-square-foot industrial property in Memphis, Tenn., as an example. We’ll calculate the NOI for a one-year period.
Operating revenue:
Lease Payments - $180,000
Total: $180,000
Property Taxes - $8,000
Insurance - $20,000
Maintenance - $44,000
Utilities - $48,000
Total: $120,000
What is net operating income in commercial real estate?
Net operating income (NOI) is a metric representative of the profitability of a commercial property. It is calculated by subtracting all operating expenses from the property’s total income. This includes revenue sources such as tenant rents, parking fees, coin laundry machines, etc., as well as operating expenses such as maintenance fees, insurance, and professional third-party contracts. NOI is an important metric because it takes all of a property’s cash flows into consideration using one simple calculation.
How is net operating income calculated in commercial real estate?
Net operating income is calculated by taking a commercial real estate asset's total income and subtracting all of its operating expenses. This includes all income sources such as tenant rents, parking fees, vending machine revenues, etc., and all operating expenses such as maintenance fees, insurance, and third-party professionals. Each commercial real estate asset is unique in its various income-producing components and its operating expenses, so it is important to consider all of these components before determining the net operating income.
For more information, please visit www.commercialrealestate.loans/net-operating-income-calculator and https://apartment.loans/posts/5-ways-for-apartment-building-owners-to-increase-revenue/.
What factors affect net operating income in commercial real estate?
Net operating income in commercial real estate is affected by a variety of factors, including income sources and operating expenses. Income sources should include all of a property’s income, such as tenant rents, parking fees, vending machine revenues, and so on. Operating expenses should include everything from maintenance fees to insurance to the contracting of third-party professionals. Common operating expenses to consider in NOI calculations are maintenance/repair costs, insurance, property taxes, property management, accounting fees, attorney fees, and marketing costs.
What are the benefits of net operating income in commercial real estate?
Net Operating Income (NOI) is a highly valuable metric for investors because it accounts for all of an asset’s inflow and outflow of cash in one simple calculation. It can be an essential part of comparing multiple potential investments and is also a critical component of a lender’s assessment of a property. NOI is also used in a number of other calculations such as determining cap rates or acquisition yields, debt service coverage ratios, and more.
In addition, NOI provides an overall metric to assess profitability of an asset. If a NOI is not sufficiently positive to cover future mortgage payments, a creditor may have concerns over a borrower’s ability to service debt.
What are the risks associated with net operating income in commercial real estate?
The risks associated with net operating income in commercial real estate include the possibility that projected net operating income may decrease substantially, resulting in the owner being liable to make principal and interest payments or even, at some point, pay back the entire loan prematurely. Additionally, due to its simplicity, NOI is not a perfect or comprehensive indicator, especially when forecasting income, and the actual NOI at the end of a period may be considerably different from the forecast.
Source: www.multifamily.loans/apartment-finance-blog/cash-on-cash-returns and www.commercialrealestate.loans/commercial-real-estate-glossary/net-operating-income-in-commercial-real-estate
How can investors maximize net operating income in commercial real estate?
Investors can maximize net operating income in commercial real estate by accurately accounting for all of an asset's income sources and operating expenses. This includes tenant rents, parking fees, vending machine revenues, insurance, maintenance fees, and any other costs associated with the asset. Additionally, investors should consider various income-producing components such as amenities, services, and other features that can increase revenue.
For more information, please see the following sources:
Operating expenses:
In this example, the NOI is calculated as seen below:
$180,000 revenue - $120,000 expenses = $60,000 NOI
Net Operating Income Calculator
What Does NOI Indicate?
As NOI provides an overall metric to assess profitability of an asset, it can be an essential part of comparing multiple potential investments.
In addition to real estate investors, NOI is also a critical component of a lender’s assessment of a property. If a NOI is not sufficiently positive to cover future mortgage payments, a creditor may have concerns over a borrower’s ability to service debt. If the owner of our industrial property in Memphis was looking for a financing package with annual mortgage payments of $55,000, lenders may have some reservations about extending credit.
NOI is also used in a number of other calculations. The figure is used to determine cap rates or acquisition yields, debt service coverage ratios, and more.
Limitations of NOI
Due to its simplicity, NOI is not a perfect or comprehensive indicator, especially when forecasting income. As both projected revenues and expenses may differ — sometimes significantly — from those input into the formula, your actual NOI at the end of a period may be considerably different from your forecast.
However, despite these drawbacks, NOI remains one of the clearest indicators in determining a property’s investment potential — even if the end result may be inexact.