So you have a real estate investment and want to maximize your positive cash flow? And how exactly is that calculated? Is cash flow the difference between the monthly rental income and the mortgage payment or is it something more? If these are questions you’ve always wondered about, then this post is for you! Read on for more information and a brief explanation of Net Operating Income (NOI), what it includes, what it doesn’t include and how it is calculated.
Net Operating Income (NOI) is simply the annual income generated by an income-producing property after taking into account all income collected from operations and deducting all expenses incurred from operations. Net operating income is positive when operating income exceeds gross operating expenses, and negative when operating expenses exceed gross operating income. For the purpose of real estate analysis, NOI can either be based on historical financial statement data or based upon forward-looking estimates or approximations, also known as a proforma. Generally speaking, investors are hesitant to rely on proforma estimates of potential performance; rather, it is much preferred to garner NOI from actual historical financial data.
Most commercial real estate investors utilize NOI, in addition to other metrics, when evaluating investment opportunities and recently many residential property management companies including Innovative Realty, LLC. are now adopting NOI as a measure in order to assist their clients in evaluating investment property as well as ensure its continuing viability.
NOI is calculated according to the following formula:
| Projected Gross Income |
- | Vacancy and Credit Losses |
= | Effective Gross Income |
+ | Other Income |
= | Gross Operating Income |
| - | Operating Expenses |
= | Net Operating Income (NOI) |
Where Projected Gross Income is income generated from all lease or rent payments. Vacancy losses and credit losses consist of income lost due to residents vacating or defaulting and may be calculated based upon financial statement data or a market driven approximation utilizing comparable property and market vacancy rates. Effective Gross Income is the amount of rental income that the owner or investor can reasonably expect to collect. Other income is any income collected other than rent and could include parking, laundry, vending, etc. Gross operating income then is the total of all income generated after considering a reasonable vacancy and credit loss factor as well as all other additional income other than rents. Operating expenses include all expenditures required to operate the property and achieve market rents. Common operating expenses include real estate and tangible personal property taxes, property insurance, management fees, maintenance and repairs, utilities, accounting, legal, etc. NOI is the final result-gross operating income less operating expenses.
NOI measures the ability of a property to produce an income stream from operation and while other metrics account for financing and taxes, the NOI figure excludes any financing or tax costs incurred by the owner or investor as in this sense, NOI is unique to the property, rather than the owner or investor.
There are some expenses that are not included in the NOI calculation. These include items such as debt service as they are specific to the owner or investor, depreciation as depreciation is not an actual cash outflow but rather an accounting entry, income taxes as like debt service, they are specific to the owner or investor, reserves for replacement (although they are not typically included in NOI calculations many investors will include it in their figures especially when financing is involved as most lenders will consider reserves for replacement as a part of determining debt service coverage ratios and the loan amount as a lender needs to know that the property is able to service debt), leasing commissions, capital expenditures and any tenant improvements (TI).Calculating the NOI is an important step in evaluating and valuing a potential investment property and once you have obtained the NOI figure, it is possible to begin looking at various other measures such as cap rate, value and the most debt which your property can reasonably support and service.
So the next time you’ll be doing an analysis of your real estate investment property, I encourage you to calculate your own NOI to accurately determine the cash flow on the potential investment property deal. Of course, if you have any questions or if there is anything Innovative Realty, LLC can do to assist you in your purchase or the management of your property, please contact our office and we are happy to assist!
Justin Recca is a professional real estate investor, speaker, marketing expert and founder of Innovative Realty, LLC, an Orlando-based real estate management company that specializes in the management of single-family homes, condominiums, town homes and small multi-family apartment communities. Justin can be reach at the office at (407) 772-5555, ext. 201 or info@innovativerealtyfl.com.
Innovative Realty’s mission is to enhance the overall quality of life of our owners, residents, team members and the community at large. We seek to maximize returns and preserve and maintain the assets of our owners while reducing the stress associated with owning investment property; provide clean, safe and well-maintained housing for our residents; provide a family-oriented, nurturing, free form yet structured environment in which our team members can work, advance and grow, both personally and professionally, and continually work to better the overall community in which we operate.