Net Operating Income (NOI)

Net Operating Income (NOI) is a key financial metric used in the commercial real estate industry. Simply put, NOI represents the annual revenue generated from a real estate property after operating expenses have been deducted but before debt service (like mortgage payments) and capital expenditures.

Formula: NOI = Gross Rental Income – Operating Expenses

Why is NOI Important?

· Profitability Indicator: NOI gives investors and property owners an idea of the profitability of a property. A positive NOI indicates the property is generating more income than its operating expenses, while a negative NOI suggests the property isn’t covering its operating costs.

· Loan Qualification: Banks and other lending institutions frequently look at NOI to determine if a property can cover its mortgage payments.

· Property Valuation: The NOI is an essential component in determining the value of a commercial property, especially when using the capitalization rate (cap rate) method.

What are Operating Expenses?

Operating expenses are the costs associated with running and maintaining a property. They include:

· Property taxes

· Insurance

· Maintenance and repairs

· Utilities

· Property management fees

· Landscaping

· Janitorial services

· Other property-specific expenses

Importantly, for purposes of calculating NOI, applicable operating expenses do NOT include mortgage payments, capital expenditures (like major renovations or upgrades), or personal income taxes. Expenses such as mortgage payments that are more specific to the owner, the owner’s financials, taxes, capital expenditures and tenant improvements are excluded from the NOI calculation to preserve the NOI calculation’s integrity measuring property-specific (and not necessarily investment- or investor-specific) cash flow coming in against cash flow going out.

How to Improve NOI?

Improving NOI can be achieved in two main ways:

· Increasing Revenue: Revenue may be increased, theoretically, by raising rents, reducing vacancies, or adding additional revenue streams (like laundry services or vending machines).

· Reducing Expenses: Property owners can negotiate better terms with service providers, make energy-efficient upgrades, or minimize unnecessary costs.

Takeaway:

Net Operating Income (NOI) is a fundamental metric in commercial real estate that provides a clear picture of a property’s financial performance. Whether you’re an investor, a property owner, or a professional offering services to the real estate industry, having a solid grasp of NOI is essential.

Want to talk to an attorney who understands your commercial real estate needs? Let's connect.