How To Calculate Net Operating Income NOI for a Real Estate Investment Property

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As a real estate professional serving investment clients, you need to be very familiar with all the methods of valuation of income properties. One of these is the calculation of Net Operating Income, as it is used with cap rate to determine the value of a property.

Difficulty: Easy

Time Required: 5 minutes

Here's How:

  1. Determine the Gross Operating Income (GOI) of the property:

    Gross Potential Income - Vacancy and Credit Loss = Gross Operating Income

  1. Determine the operating expenses of the property. This would include expenses for management, legal and accounting, insurance, janitorial, maintenance, supplies, taxes, utilities, etc.
  2. Subtract the operating expenses from the Gross Operating Income to arrive at the Net Operating Income. Using the example of a property with a gross operating income of $52,000 and operating expenses of $37,000, our net operating income would be:

    $52,000 - $37,000 = $15,000 Net Operating Income

Commercial lenders use different qualification criteria to determine if a mortgage is warranted and how much they will loan against a property.  The investor owners usually aren't individually evaluated as to their credit history, as it's not as important to the lender as the income generation potential of the property to be mortgaged.

The fact is that a home buyer is going to live in the home they're buying, so the lender evaluates their ability to pay the mortgage and their history of paying debt obligations.

 It's a very different situation from a commercial property, let's say an office complex.  The buyers are buying this property for one single purpose; to generate positive cash flow from rental income.

The motivation for the purchase is income, so the lender wants to evaluate the property based mostly on the income it will generate.

 Sure, property condition and other factors enter into the mortgage qualification, but income is the big factor.  If the property can service the debt (pay the mortgage payments) and still have an acceptable monthly income cash flow, then a mortgage is likely to be initiated.

If the ratios wanted by the lender based on income are not pointing to approval, the borrowers can come up with more cash for a down payment to bring the ratios into line.  Net Operating Income is very important in commercial lending.

Tips:

  1. Be very careful to get all the operating expenses into the calculation. Missing expenses will increase net operating income and thus cause your client to overpay for the property based on valuation using cap rate.
  2. For the most used investor calculations explained and a spreadsheet to calculate them, take this link.

What You Need:

  • Calculator
  • Comprehensive itemization of operating expenses.

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