Net Operating Income (NOI) is a key calculation in evaluating the performance and profitability of a real estate investment. It is the income generated from a property after operating expenses but before debt service (mortgage payments), capital expenditures, and taxes. It's a pre-tax figure that indicates the property's ability to produce income.
Here's how to calculate NOI:
Net Operating Income (NOI) = Gross Rental Income - Operating Expenses
As discussed earlier, Gross Rental Income is the total rent collected from the property.
Operating Expenses include property taxes, insurance, repairs and maintenance, property management fees, and any utilities or services you, as the landlord, are responsible for.
So, for instance, if you collect $3,000 per month in rent from a property ($36,000 per year), and your total operating expenses for the year are $15,000, your NOI would be $21,000 ($36,000 - $15,000).
It's crucial to note that NOI does not account for mortgage payments or financing costs. This is because NOI is designed to measure the property's income-producing potential, regardless of how it's financed. This allows for an "apples to apples" comparison between different properties.
A positive NOI indicates that the property's income covers all operating expenses. A negative NOI, on the other hand, suggests that the property is not generating enough income to cover operating costs and could indicate a poor investment unless the negative cash flow is temporary and other factors make the investment worthwhile (e.g., potential for significant appreciation).
Investors often use NOI to determine the value of a property through the capitalization rate (cap rate). The cap rate is the ratio of the NOI to the property's purchase price or market value, which can indicate the potential return on investment.
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