If you’re investing in real estate, knowing your numbers is key. One of the most critical metrics? Net Operating Income (NOI). But what is NOI in real estate, and how does it impact your investments? Keep reading to learn how NOI works, why it matters, and how to calculate it correctly.
What is NOI in Real Estate?
Net Operating Income, or NOI, is a key metric in real estate that shows how much profit a property generates. Simply put, it’s the income a property brings in after covering all operating expenses—excluding taxes, mortgage payments, and depreciation. The savviest landlords and property managers in Baltimore use NOI to assess a property’s financial health and find ways to improve its value over time.
Why is NOI Important in Real Estate Investing?
Now that we know what NOI is, let’s look at how it helps in real estate investing.
NOI shows how much income a property generates after expenses, making it a key factor in evaluating profitability and investment potential. As such, investors use NOI to compare properties, estimate value, and make more informed choices. More specifically, it helps you in the following ways:
To Find Your Cap Rate
One common way people use their NOI is to find their cap rate. A cap rate compares your NOI to your property’s market value to find that property’s projected returns.
Cap Rate = NOI/Market Value.
For example, if you have a $50,000 NOI and a $1,000,000 market value, the cap rate (and your property’s returns) will be 5%.
To Compare Properties
You can use one property’s NOI to compare it with the NOI of other properties in your portfolio. This way, you can measure whether each property is bringing enough income in proportion to your other ones. If one of them seems disproportionately low compared to the others, you can pinpoint what you need to do to get it to speed.
To Find Your Property Value
In addition, you can use your cap rate (and by extension, your NOI) to find your property value. For example, if a property generates $100,000 in NOI and the typical cap rate in that area is 8%, you can calculate its estimated value like this:
Property Value = NOI ÷ Cap Rate
$100,000 ÷ 0.08 = $1,250,000
As a result, the property would be worth $1.25 million based on an 8% cap rate. This quick calculation helps investors determine whether they’re getting enough bang for their buck.
Takes both income and property appreciation into account, giving a full picture of the investment’s overall performance.
How to Calculate NOI in Real Estate
To calculate your NOI, there are some steps you need to follow. They go as follows:
Formula
NOI = Total Revenue – Operating Expenses
Example
Suppose you own a multifamily rental property in Howard, DC, generating $100,000 in annual rental income. If the total operating expenses—covering property taxes, repairs, insurance, and management fees—amount to $40,000, the NOI calculation would be:
NOI = Total Revenue – Operating Expenses
$100,000 – $40,000 = $60,000
A higher NOI indicates a more profitable property, while a low or negative NOI may suggest high expenses or poor income performance. If the total is negative due to higher operating costs; it’s referred to as a Net Operating Loss (NOL).
What Investors Factor into Their NOI
But what does this formula that actually mean in real-world terms? To find NOI = Total Revenue – Operating Expenses, you have to
- Determine your revenue
- Subtract your operation costs
These might sound like simple, straightforward terms, but they actually involve parts of your business you might not typically think about. For example, when most people hear “rental income,” they immediately conjure up rent payments in their heads, but it’s so much more than that.
Income Sources
- Rent Payments– The obvious one is money collected from tenants.
- Parking Fees – If the property has parking spaces, tenants may pay extra for them.
- Laundry Machines – Coin-operated or card-based laundry setups bring in extra cash.
- Other Fees – These could be storage rentals, late payment fees, or even shared utilities.
And as for operating costs, there are countless things you need to consider in your calculations, such as:
Operating Costs
- Property Management Fees – If a management company handles the property, they take a cut.
- Property Taxes – These vary based on location but are a key cost.
- Repairs & Maintenance – Keeping the place in good shape costs money.
- Insurance – Protecting the property with the right coverage is non-negotiable.
- Utilities (if covered by the owner) – Sometimes landlords foot the bill for water, electricity, or gas.
- Janitorial Services – If there are common areas, they need to be cleaned regularly.
The Limitations of NOI
While NOI is a valuable metric, it does have some limitations. Understanding these can help you make better investment decisions. Here’s what you should keep in mind:
- It Doesn’t Include Loan Payments or Taxes – NOI looks at income and operating expenses. That’s it. It doesn’t consider mortgage payments, capital reserves (money set aside for big repairs), or taxes, which are important costs for property owners.
- Accuracy Depends on Expense Tracking – To get a reliable NOI, all income and expenses must be recorded correctly. If you have any missing or misclassified expenses, that can give you inaccurate results.
- It’s Not the Full Picture – Yes, your NOI is important, but it’s not the only thing that matters. For you to really understand a property’s financial health, you also need to look at things like cash flow, cap rate, and total return. These numbers can give you a clearer picture of where you’re at and help you to make better investment choices.
Common Mistakes When Calculating NOI (And Possible Solutions)
Even experienced investors can make errors when calculating NOI. Here are some common mistakes and ways to avoid them:
Problem: Ignoring Hidden Costs
It’s easy to overlook some expenses when calculating the Net Operating Income (NOI) of a property. However, you should be sure not to. Seasonal maintenance, like landscaping and snow removal, can add up over the year. Furthermore, legal fees for tenant disputes or compliance issues, as well as unexpected repairs like plumbing or electrical issues, can also impact your bottom line. These hidden costs might not be immediately apparent, but they can significantly affect your property’s profitability.
Solution: To ensure you make the most accurate NOI calculation possible, it’s essential to account for all possible costs, including irregular and unexpected ones. Conducting a thorough review of past expenses and consulting with property management professionals can help you identify and include these hidden costs in your financial planning.
Problem: Assuming Your Property is 100% Occupied
While it may be tempting to assume that a property will always be fully rented out, this is rarely the case in reality. Factors such as market demand, property location, and tenant turnover can all affect your occupancy rates. Assuming 100% occupancy can lead to overly optimistic revenue projections and may lead to you facing financial shortfalls if vacancies occur.
Solution: To avoid having inflated revenue estimates, use a realistic occupancy rate based on market trends and historical data for similar properties in the area. This approach can give you a more accurate snapshot of your potential rental income and help you make better-informed investment decisions.
Problem: Misclassifying Expenses
Not all costs associated with a property should be included in your NOI calculation. For example, capital expenses, such as major renovations, and loan payments are typically excluded from NOI. Including these costs can distort the property’s true financial performance and give you incorrect valuations.
Solution: Clearly separate operating expenses from capital expenditures and debt-related costs. Operating expenses are regular, recurring costs that you need to make for the property’s day-to-day operations, while capital expenditures are investments you make for long-term improvements. By keeping these categories separate, you can make sure you’re making the most accurate NOI calculation possible.
Problem: Not Including Vacancies and Unpaid Rent
Even the most popular properties are bound to go through periods of vacancy and tenant defaults. If you fail to account for these potential losses, it can result in an overly optimistic NOI. In turn, you could be caught unprepared by financial difficulties when they inevitably occur.
Solution: When estimating rental income, factor in realistic vacancy rates and potential losses that tenant defaults could bring. Reviewing historical data and current market conditions can help you develop more accurate projections and better prepare for these eventualities.
Problem: Failing to Adjust for Market Changes
The real estate market is dynamic, with rents, property taxes, and maintenance costs fluctuating over time. Failing to adjust for these changes can result in outdated and inaccurate NOI estimates, which may impact your investment decisions.
Solution: Regularly update your NOI calculations based on current market conditions. Also, stay informed about changes in rental rates, taxes, and maintenance costs by monitoring market reports and consulting with local real estate professionals. Being proactive will help you maintain accurate NOI estimates and make more informed investment decisions.
Ready to Maximize Your Property’s Profitability?
To answer, “what is NOI in real estate,” it’s the net operating income you make from a property after factoring expenses. To get the best NOI possible, you should be sure to factor in all applicable revenue and hidden operating costs, possible vacancies, unpaid rent, and market changes. By staying diligent, you can keep your investment healthy.
At Bay Property Management Group, we don’t just take care of your property—we help you increase your Net Operating Income (NOI) and maximize your returns. Our professionals can analyze your target market to ensure you’re offering the most optimal price possible for your rental. Then, we can market to tenants in your area and narrow down qualified applicants for you. We also can help you get better deal on maintenance and repair services, handle accounting on your behalf, and more. Sounds good to you? Contact us today to get started!
