How to Calculate Net Operating Income for Rental Properties
May 25, 2022
Invest confidently in real estate
Invest confidently in real estate
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Net operating income (NOI) is used to help understand the profitability of a rental property. It is used by several formulas for calculating essential metrics real estate investors should understand, like cap rate and cash-on-cash return. In this article you’ll learn how to calculate NOI, what expenses are included or excluded, and how NOI is used to evaluate rental properties.
NOI is the annual amount of money generated by a rental property, the gross operating income, minus its operating expenses. It is unique to the property itself and does not include expenses specific to the investor or borrower, like mortgage payments.
NOI = gross operating income – operating expenses
Let’s look at the individual pieces of the calculation: gross operating income and operating expenses.
Gross operating income will include rental income and other potential income generated by the property. Examples of other income include coin laundry, storage unit rentals, or additional parking. Gross operating income also allows for the potential of lost income due to vacancy. For example, if you expect 3% vacancy in a year, you will reduce rental income by that vacancy allowance.
Gross Operating Income = rental income + other income – vacancy allowance
Operating expenses include the expenses incurred only for operation of the property. This includes things like property taxes, HOA dues, insurance, property management, maintenance & repairs, misc. Remember that expenses related to the owner like the debt service, are not included as operating expenses.
Cap Rate uses NOI to help investors understand the rate of income relative to its market value. It is an effective way to compare different properties that have different sizes, amenities, and values. If you can increase NOI, and the cap rate of the neighborhood remains consistent, your property value will rise – this strategy can be effective for investors who are considering an exit strategy and want to maximize their return.
Cap rate = NOI / property value
You can learn more about cap rate here.
Cash-on-Cash (CoC) return is a metric used to evaluate the earnings on a real estate investment relative to the cash invested in that property. It compares pre-tax earnings to the amount of cash invested in a property.
CoC Return = annual NOI / cash invested
You can learn more about CoC return here.
The Padvest property evaluation report is a quick and easy way to estimate NOI for a property you are considering. The report will pre-populate the vacancy rate using industry data for this calculation. Simply enter the address of the property, customize important variables to your strategy, and you can get a detailed financial evaluation of the property. At the bottom of the report, you can see the estimated NOI over five-year increments.
Learn more about Padvest Research and sign up today to evaluate your next rental property investment.
