What is Net Operating Income?
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.
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.
Lease Payments - $180,000
Property Taxes - $8,000
Insurance - $20,000
Maintenance - $44,000
Utilities - $48,000
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.