What is a Net Operating Income?
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Net operating income (NOI) is a crucial multifamily metric that helps investors understand the profitability of a property. This is a key factor in determining the property's value. But what exactly is net operating income?
Basically, net operating income is the income generated by a property minus its operating expenses. It’s the amount of money the property brings in after all the expenses are paid. In multifamily real estate, operating expenses can include things like:
- property taxes
- insurance
- maintenance
- utilities
- property management fees
To calculate net operating income, you subtract the operating expenses from the property’s gross income. Gross income is the total revenue generated by the property, including rental income, late fees, pet fees, and any other sources of income.
Here’s an example:
Let’s say you own a multifamily property that generates $500,000 in annual rental income. After deducting vacancy and credit losses, the effective gross income is $450,000. You also have operating expenses totaling $150,000, which include property taxes, insurance, maintenance, utilities, and property management fees. Your net operating income would be $300,000 ($450,000 – $150,000).
So, why is net operating income so important in multifamily real estate investing?
Well, it’s a key factor in determining a property’s value. In fact, many investors use the cap rate formula to estimate a property’s value based on its net operating income. Cap rate is short for capitalization rate, and it’s a metric that measures the rate of return on a property investment.
The formula for cap rate is simple: divide the net operating income by the property’s value. For example, if a property has a net operating income of $300,000 and is valued at $3 million, its cap rate would be 10% ($300,000 / $3,000,000).
Cap rate is a useful tool because it allows investors to compare the returns of different properties. A property with a higher cap rate is generally considered more attractive because it offers a higher rate of return on the investment.
So, net operating income tells investors how much money a property is generating after all the operating expenses are paid. By using the cap rate formula, investors can estimate a property’s value based on its net operating income and compare the returns of different properties. Understanding net operating income is key to making informed investment decisions in the multifamily real estate market.
As you continue to educate yourself about the vocabulary and concept of real estate investing, check out these recent posts, as well:
The more you know, the better equipped you will be to make investment decisions.
