Calculating Net Operating Income ( NOI ) for investment properties

Properties with more than 3 rental units are generally considered commercial properties. Qualifying for commercial loans often requires higher documentation and greater analysis of the rental income.  Calculating Net Operating Income can help determine the fair market value for these and other investment property types.

Greg Zaccagni @ www.MortgageAdvisor.info

Net Operating Income or NOI is equal to a property's yearly gross income less operating expenses.  Gross income includes both rental income and all other income associated to the property such as parking fees, laundry and vending receipts, etc.  Operating expenses are costs incurred during the operation and  maintenance of a property.  They include repairs and maintenance, insurance, management fees, utilities, supplies, property taxes, etc.  The following are not operating expenses: principal and interest, capital expenditures, depreciation, income taxes, and amortization of loan points. Net operating income is calculated like this.

Income

    Gross Rents Possible

120,000

    Other Income

    3,000

Potential Gross Income

123,000

    Less vacancy Amount

    2,000

Effective Gross Income

121,000

    Less Operating Expenses

  31,000

Net Operating Income

  90,000

Net operating income or "NOI" is an essential ingredient in the Capitalization Rate (Cap Rate) calculation that is used to estimate the value of income producing properties.  Lets assume we have a market capitalization rate of 10 for the type of property we are considering purchasing.  A market cap rate is calculated by evaluating the financial data from current sales of similar income producing properties in a given market place.  We are evaluating a similar income property that is currently for sale with a net operating income of $90,000.  We would estimate the value of this property like this.

The NOI will enable you to calculate a Debt Coverage Ratio or "DCR." Lenders and investors use DCR to measure a property's ability to pay it's operating expenses and mortgage expense.  A debt coverage ratio of 1 is breakeven.  Most lenders require minimum of 1.1 to 1.3 to be considered for a commercial loan.  From a a bank's perspective, the larger the debt coverage ratio, the better.   Debt coverage ratio is calculated like this.

Debt service is the total of all interest and principal paid on a loan in a given year.   It is equal to the mortgage payment(s) times 12.

Net Operating Income is important in several real estate ratios which include the Capitalization Rate, Net Income Multiplier and the Debt Service Coverage Ratio.  It is also an essential part of an income property's Income & Cash Flow Statements.