NOI (net operating income) is one of the fastest and easiest ways to determine whether you should buy an investment property. In this guide to NOI real estate, we’ll show you how to not only calculate this figure but also use it to make savvy investing decisions!
NOI in real estate is a metric used by real estate investors to determine the profitability of an investment property. NOI is calculated by subtracting the property’s operating expenses from its income. Take note: operating expenses do NOT include mortgage payments!
Because it is a before-tax calculation, NOI also excludes depreciation, CapEx (capital expenditures), and amortization. The term NOI is specific to real estate, but a similar measurement, EBIT (earnings before interest and taxes), is used throughout other industries.
In addition to offering a glance at a property’s potential profits, the NOI calculation can be plugged into other formulas to form a well-rounded assessment of the property you’re analyzing. Investors use NOI in several ways:
The strong correlation between NOI and profitability allows you to streamline deal analysis. Calculate a property’s NOI and compare it to that of multiple investment properties within a given market.
Capitalization rate, or cap rate, is the projected return on investment (ROI) for a property through one year. To calculate cap rate, divide your annual net operating income by the total property value. For example, if you have an annual NOI of $20,000 on a $400,000 property, your cap rate will be .05, or 5%.
After calculating your net operating income, it’s easy to tell whether the property will be able to cover your mortgage payment. Simply compare your NOI to the amount of principal and interest you will need to pay down each month.
If you know how much mortgage you can afford for your next investment property, you can set your NOI requirements accordingly and easily weed out properties that don’t meet your criteria.
You could calculate NOI by hand, but fortunately, you don’t have to! Rent to Retirement’s Rental Property Calculator does all the heavy lifting. Just enter the purchase price, down payment, interest rate, and your expenses for a full analysis of the property. The best part? You can use this tool to calculate not only NOI but also cash flow, cash-on-cash return, and other key metrics.
To run the numbers on your own, use this simple formula:
Revenue – Operating Expenses = Net Operating Income
Your total revenue should include not only rents but also parking fees, laundry machine revenue, and any other income streams generated by the property. Your operating expenses should include insurance, maintenance, repairs, property taxes, property management fees, and utilities.
Let’s say you buy a turnkey rental. Turnkey rentals have very few repair and maintenance expenses, but they do have most other operating expenses, such as insurance, property management, and property taxes. If your turnkey real estate investment brings in $2,500 per month in rent with $100 in repairs, $250 in property management fees, $150 in insurance, and $150 in property taxes, your NOI will look like this:
Looking for High NOI Investment Properties?
Many investors conflate net operating income, net cash flow, and net profit, but NOI specifically excludes “below the line” items, such as debt service, income taxes, and others.
To improve your NOI, you will need to increase your revenue, decrease your operating expenses, or both. There are several strategies you can use to achieve this:
One of the many advantages of buying turnkey properties is that they are fully repaired and renovated before you buy them. With less maintenance and fewer repairs, you can keep your operating expenses low for many years and enjoy a higher NOI.
Raising rents without inflating your operating expenses is a surefire way to boost your NOI. Are you under market rent? Find out what you should charge for rent with tools like Rentometer and BiggerPockets Rent Estimator.
While long-term rentals may deliver predictable income, consider trading the comfort of those consistent rent checks for the higher revenue potential of short-term or medium-term rentals. Pivoting to one of these strategies could boost your income and effectively increase your NOI.
If you pay for utilities, make them your tenant’s responsibility at renewal or turnover. Depending on local regulations, you may even be able to implement a ratio utility billing system (RUBS), which allows you to bill each tenant for a portion of their building’s utilities. This move has a significant impact on NOI, as it simultaneously boosts revenue and reduces operating expenses.
Gross operating income (GOI) differs from NOI in that it represents an investment property’s total revenue after vacancy loss but before any operating expenses are deducted. To calculate GOI, subtract 5-10% of all rent (or your anticipated vacancy rate) from your property’s total income.
Both NOI and EBITDA measure profitability, but they have different applications. We use NOI in real estate to calculate an investment property’s profitability, but EBITDA (earnings before income, taxes, depreciation, and amortization) is used to assess company performance across various industries.
Cap rate is an essential metric for comparing properties in commercial real estate, but this figure can be useful in residential real estate as well. Calculate cap rate by taking your annual NOI and dividing it by the property value, or use the free Rent to Retirement cap rate calculator to find out in seconds!
If you want an investment property with a high yield, consider a turnkey rental property. Rent to Retirement has some of the best NOI turnkey rentals in the nation. These move-in-ready homes are recently repaired and renovated, allowing you to keep your operating expenses to a minimum and maximize your profits!
NOI is a metric that real estate investors use to quickly determine the profitability of an investment property. You can calculate NOI by subtracting any operating expenses from your total revenue.
No, you should not include any mortgage payments or amortization when calculating NOI. Debt service is not considered an operating expense, and these costs vary greatly from one investor to the next.
While NOI and EBITDA are both used to measure profitability, NOI is specific to real estate investments. EBITDA, on the other hand, is used to evaluate companies across all types of industries.