What is the Importance of Net Operating Income in Regards to Commercial Real Estate?
Net Operating Income (NOI), is the net income generated by a property after deducting operating expenses. The NOI measures the ability of a property to generate income from operations as a single project. The NOI only accounts for the property in question and no other operations.
Income mostly consists of rent but could also include revenue such as parking fees, vending machines, laundry machines or service charges. The operating expenses are expenditures incurred when running and maintaining the property, such as insurance, property tax, and utilities. NOI is a before-tax figure that measures the cash generated by a property. It also excludes principal and interest payments on loans, capital expenditures, depreciation, and amortization. NOI is calculated with this formula:
Net Operating Income= Gross Income- Operating Expenses
NOI is one of the most important metrics that a lender will look at commercial property loan evaluation. It also helps investors to measure a property’s anticipated cash flow.
How NOI Works in Practice
Below, we've provided an example of a basic NOI calculation :
Therefore, we can see that the net operating income of a property is, in general terms, its gross potential rent (GPR), plus other income, such as percentage rent, minus vacancy, credit loss, and expenses, such as repairs and maintenance (R&M), as well as property taxes and insurance.
NOI, along with other commercial real estate metrics, such as internal rate of return (IRR) and net present value (NPV), are some of the most effective ways to determine the potential profitability of a commercial property.