What is NOI in Real Estate?

Net Operating Income (NOI) is a financial metric used in real estate to measure a property’s potential profitability. It represents the total revenue generated by a property minus all necessary operating expenses. This calculation gives investors and property owners a clear picture of a property’s ability to generate income before considering debt service, income taxes, or capital expenditures.

It’s important to note the difference between NOI and ROI, which stands for Return On Investment. While NOI shows a property’s operational income potential, ROI looks at the total return beyond the revenue a property generates. It encompasses other considerations like a property appreciating value and how market conditions can affect the investment.

How is NOI Used in Real Estate?

NOI is the annual income generated by a property after deducting all operating expenses. Operating expenses include:

• Property management fees
• Insurance
• Utilities
• Maintenance and repairs
• Property taxes
• Janitorial services

However, NOI does not include mortgage payments, depreciation, or capital expenditures.

Investors and property developers need to grasp how NOI is used in real estate. In property valuation, NOI helps determine a property’s market value using the capitalization rate method. Investors rely on NOI to compare different properties and make informed investment decisions, while lenders use this metric to calculate debt service coverage ratio (DSCR) and determine lending risk. Property owners regularly monitor NOI trends to assess management effectiveness and property performance. Additionally, NOI plays a crucial role in budget planning, helping create accurate financial projections and identifying areas for cost reduction or revenue improvement.

The NOI Formula

Here’s the basic formula to calculate Net Operating Income:

NOI = Gross Operating Income – Operating Expenses

Gross Operating Income covers rental income plus anything else you charge for, like parking or laundry machines. Potential income doesn’t count—if you have vacant units in a multifamily building, for example, their rent potential isn’t included in GOI. Operating Expenses are all the necessary costs to run and maintain the property, like repairs and maintenance. It also includes expenses like property taxes or marketing the property.

Who Needs to Use This Metric?

Many stakeholders rely on NOI calculations to predict and protect their investments. 

• Real estate investors evaluating potential properties
• Property managers tracking operational performance
• Commercial lenders assessing loan applications
• Real estate appraisers determining property values
• Commercial real estate brokers analyzing deals
• Property owners monitoring investment performance

It’s not just accountants that need to crunch the numbers in real estate. If you have a stake in a property, mastering metrics like NOI can help you maximize your profits and get smarter returns. Construction finance software like Rabbet makes tracking all these metrics much easier. Keep reading about the solutions Rabbet provides for real estate developers and commercial lenders.