April 22, 2016
By David Saba
Net operating income (NOI) refers to the total amount of pre-tax revenue generated from a real estate investment after all of the relevant operating expenses have been paid. Generally speaking, real estate investors aim to achieve a favorable NOI, however, in some cases, there can also be a net operating loss (NOL) during periods when expenses related to the property exceed the income it generates.
NOI can be calculated on a monthly, quarterly or annual basis, depending on the type of rental property and length of each tenancy. To keep things simple, we'll assume all calculations here are based on yearly figures.
Factors Impacting the Net Operating Income of Residential Investment Properties Simply put, the ROI on a residential investment property includes the following factors:
Generally speaking, most residential real estate investors calculate vacancy losses at 10%.
Start by Calculating the Gross Operating Income of the Property
To calculate the GOI on a property, simply add up the total income that would be generated each year based on 0% vacancy rates and full payment of rental fees - this is the Gross Potential Income (GPI).
On a unit that rents for $2,000 monthly, the total GPI is $24,000. To determine the GOI, simply multiply the annual GPI of $24,000 by 10% - the estimated losses resulting from vacancies and non-payment of rent.
The gross estimated losses would be $24,000 x .10 = $2400.
The GOI is therefore $24,000 (the GPI) minus the gross estimated losses of $2400
= $21,600 Gross Operating Income.
What to Include in Operating Expenses
For the purposes of calculating the NOI of a property, the following should be included as operating expenses:
Operating expenses do not include capital improvements, such as major renovations. Also excluded are mortgage payments/interest, depreciation, and income tax. Even though the mortgage interest may be used as a tax-deductible expense, it is not deemed to be an operating expense.
Calculating the Net Operating Income on a Residential Rental Property The formula used to calculate the net operating income on a residential property is: Gross Potential Income (GPI) - Vacancy and Non-Payment of Rent = Gross Operating Income (GOI)
From the Gross Operating Income (GOI), subtract the total operating expenses to determine the Net Operating Income.
To determine the NOI on a residential investment property, start by adding up the monthly rental income, then multiply this number by 12 to arrive at the annual total:
$2,000 monthly rent x 12 months = $24,000 - this is the gross potential income (GPI)
Next, assume a 10% annual loss based on vacancy and non-payment of rents by multiplying the total GPI of$24,000 x .10 (10%) = $2400
Subtract $2400 from $24,000 = $21,600 - this is the gross operating income (GOI).
Now, add up the total annual operating expenses - let's put this number at $10,000.
Simply subtract the operating expenses ($10,000) from the GOI ($21,600) to determine the NOI.
In this example, the NOI is $11,600.
The NOI is a must-know figure for any investor looking to purchase residential properties - it serves as the foundation for determining the capitalization rate of the property, which in turn helps investors and lenders understand whether the income from the property is sufficient to cover debt repayments and investment targets.
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Writer at AssetColumn.com
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