Maximizing Net Operating Income in Real Estate: Definition & Formula

If you’ve stumbled upon this article, you’re probably wondering what the heck “NOI” is and how it relates to the real estate industry. 

Good news for you, you’re in the right place! 

When it comes to making smart decisions and maximizing your profits, understanding NOI is an absolute must. That’s why we'll cover everything you need to know from how to calculate it, why it's so important, and even how proptech plays a role in optimizing NOI. 

Navigate this article:

• What is NOI and Why Does it Matter? 
• How to Calculate Net Operating Income in Real Estate
• Determining Cap Rate with NOI 
• Strategies to Maximize Your Net Operating Income 
• The Impact of Proptech on NOI

Let’s get started! 

What is NOI and Why Does It Matter?

Net Operating Income (NOI) is a valuation tool used in real estate to assess the profitability of an income-generating property. It holds significant importance in the realm of real estate for several reasons: 

1. Property Valuation: Firstly, it serves as a key indicator for evaluating the profitability and financial performance of a property. By deducting operating expenses from the property's income, NOI provides a clear picture of the revenue generated solely from its operations. This helps investors determine whether a property is worth purchasing. 
2. Budget Planning: NOI plays a crucial role in setting a budget for a given property. By analyzing the property's income and expenses, investors can establish a realistic budget that takes into account operational costs, debt service, and potential returns. 
3. Loan Terms: NOI plays a vital role in helping investors make educated decisions and negotiate loan terms. A higher NOI strengthens the investor's position during loan negotiations, increasing the likelihood of securing favorable loan terms and conditions.

How to Calculate Net Operating Income in Real Estate

Calculating NOI involves a straightforward formula:

NOI = Gross Operating Income - Operating Expenses

Gross operating income includes revenue from:

• Rental Income
• Parking Fees
• Amenities and Services
• Vending Machines
• Laundry Facilities

Operating expenses often include: 

• Property Management Fees
• Property Taxes
• Repairs and Maintenance
• Property Insurance
• Utilities
• Janitorial Services

Why isn’t CapEx included in NOI? 

While properties have recurring costs to keep the building maintained and running smoothly, NOI does not include one-time capital expenditures (CapEx) for major asset upgrades or replacements. 

By excluding CapEx from the calculation of NOI, it allows investors and analysts to focus specifically on the property's operating performance and profitability.

Does NOI Include Real Estate Taxes?

NOI does include property taxes. Real estate taxes – the cost of the land and anything permanently connected to the land  –  are part of the operating expenses considered in the NOI calculation. However, NOI is determined before income tax deductions.

Now that you know what data to gather, let’s look at an example.

Monthly Revenue

• Rental income: $10,000
• Parking fees: $2,000
• Laundry facilities: $500
  • Total revenue: $12,500

Monthly Operating Expenses

• Property management fees: $1,000
• Property taxes: $1,500
• Repairs and maintenance: $800
• Property insurance: $500
  • Total expenses: $3,800

To calculate the NOI, subtract the total expenses from the total revenue:

NOI = Total revenue - Total expenses

= $12,500 - $3,800

= $8,700

In this case, the Net Operating Income is $8,700.

🐥 Remember that this is just a simplified example, and in a real-world scenario, there may be additional revenue sources and operating expenses to consider. 

Estimating your property’s yearly NOI? The calculation above can be applied on an annual basis by multiplying the monthly NOI by 12. This method will give a fair estimate but will not be exact since several factors are prone to fluctuate throughout a fiscal year (including rental income). 

Determining Cap Rate using NOI 

NOI is also a key factor in several other metrics including cap rate. 

Many investors consider the cap rate to be the most important metric in real estate as it provides investors with a standardized measure to compare the expected returns of different properties. 

Much like NOI, the formula is rather simple.

Capitalization rates (cap rates) = NOI / the purchase price

Other Parameters that are Dependent on NOI 

• Cash on cash return is a metric commonly used by investors to evaluate the annual returns on their cash investments. It is typically calculated in relation to the initial cash investment made in a specific property.
• Net cash flow (NCF) is determined by subtracting both capital expenditures (CapEx) and debt services (DS) from the property's NOI.
• Return on investment (ROI) is calculated by dividing the NOI generated by the property's purchase price, and then multiplying the result by 100 to obtain the ROI percentage. ROI is a vital tool for evaluating the potential of a property.

Strategies to Maximize Your Net Operating Income 

If you’re to boost your property’s NOI, try one of the following strategies. 

1. Minimize Operating Expenses: Reduce operating expenses, also referred to as OpEX, whenever it makes sense. Explore cost-saving measures such as obtaining multiple bids for contractor jobs, implementing energy-efficient solutions, and leveraging automation technologies like LittleBird’s access control system to streamline operations. 
2. Increase Rental Income: Incremental increases in rental rates can significantly impact your NOI over time, but be careful about raising rent without increased value for current and future residents. Buildings are easy to leave, but a community makes all the difference in resident retention. Be thoughtful in your efforts to engage your residents in activities that encourage building relationships and connections to the community around them. 
3. Charge Fees for Amenities and Services: Providing desirable amenities and services can generate additional revenue streams. In light of the COVID-19 pandemic, more residents continue to work from home and desire a place outside of their apartments to do so. Consider adding co-working spaces residents can reserve for a small fee. Modern day residents also desire amenities that add convenience and safety to their daily life. This can be translated into robust access control systems, smart home technology, or storage facilities.

The Impact of Proptech on NOI

Proptech, or property technology, has transformed the real estate industry by offering innovative solutions that directly impact NOI. These advancements in proptech have significant effects on NOI in three key ways.

Watch How LittleBird's All-in-One Solution Works:

1. Improves Operational Efficiency

Firstly, proptech enhances operational efficiency by automating manual tasks and streamlining processes. This allows property staff to shift their focus towards resident engagement, retention, and other value-added services. By reducing time-consuming activities, property teams can improve their overall productivity and effectiveness.

2. Reduces Operational Costs

Secondly, proptech solutions contribute to cost reduction by optimizing resource allocation, minimizing energy consumption, and lowering maintenance costs. By implementing automated systems for access control, visitor management, and building maintenance, property owners can utilize resources efficiently and achieve significant cost savings.

3. Improves the Resident Experience 

Lastly, proptech improves the resident experience through smart building solutions. 

These technologies provide seamless access control, personalized services, and enhanced convenience and comfort for residents. By prioritizing resident satisfaction, property owners can increase occupancy rates, potentially raise rents, and ultimately drive higher NOI.

FAQs

Does NOI include debt service?

The short answer is no. NOI does not include debt service, which is the principal and interest payments made on a loan. Debt service is considered a financing activity and not an operating expense. Therefore, when you calculate NOI, you only take into account revenues earned from the property and the expenses associated directly with its operation, such as maintenance, utilities, property management fees, and property taxes. Loan repayments or interest charges are excluded.

Final Thoughts…

• Net Operating Income (NOI) is a crucial metric that plays a pivotal role in real estate. 
• By implementing cost-saving measures, increasing rental income, and leveraging proptech solutions, you can enhance your property's NOI and overall profitability.