Net operating income, or NOI, is a critical metric used by commercial real estate investors. It is calculated by deducting a property's operating expenses from its potential rental income.
These expenses include utilities not passed on to tenants, property management fees, and property taxes. However, mortgage payments of principal and interest are not considered an operating expense.
Commercial property rental income is the main source of revenue for most properties. Other sources of income include parking fees, security deposits, and service charges. Operating costs are subtracted from revenue to produce net operating income or NOI. Operating expenses include building and grounds maintenance, janitorial services, insurance, utilities, property management, and legal fees. A few items are generally excluded from the NOI calculation: debt service, mortgage amortization, and depreciation.
It's important to understand what's included and excluded from operating costs. For example, the landscaping cost isn't an operating expense if tenants' rent payments cover it. However, if the landlord pays for landscaping and then passes on those costs to tenants in their lease agreements, this would be an operating expense. Also, the owner's personal income taxes and mortgage payments aren't considered part of a property's operating expenses. This allows evaluation of a property's performance independent of capital structure and financing costs.
Commercial real estate has unique income sources that distinguish it from residential properties. Professionals at Caliber, for instance, believe in the potential of these non-rental income sources to boost overall revenue. These sources may include parking fees, laundry revenues, vending machine profits, pet rent, storage unit charges, and more.
Other income is an essential component of gross potential income (GPI), which represents the total amount of cash flow a property could generate if all units are full and rented at market rates. This figure is then subtracted from the total operating expenses to calculate net operating income or NOI.
NOI is a key metric for CRE investors, lenders, and appraisers. It allows them to analyze a property's profitability and cash flow. It considers a property's revenue streams, including non-rental income and operating expenses, such as maintenance/repair costs, insurance, third-party professional services, etc. It does not consider mortgage payments or debt services, which are considered financing expenses and are typically excluded from the calculations.
Often abbreviated as OpEx, operating expenses are the property's cost of doing business. These include maintenance fees, insurance costs, and the contracting of third-party professionals. They should be subtracted from potential gross income to produce net operating income (NOI).
Using NOI projections can provide a property owner with insight into its performance before considering financing and tax costs. As a result, NOI is an important measure for investors and appraisers.
As a tenant, you should be hyper-aware of your landlord's operating expense calculations. While it might seem that the landlord is paying these expenses based on your square footage, this is only sometimes the case. Tenants should seek a lease agreement with an operating expense clause that allows only normal out-of-pocket costs. For example, your landlord should not remeasure your space to justify higher maintenance expenses on your building. Such a move could be construed as a breach of your lease.
There are many important commercial real estate terms to know, including capitalization rates, debt coverage ratios, and net operating income. Net operating income is the value of a revenue-generating property minus all operational expenses. This includes rent money, fees from parking or laundry facilities, and other revenue streams. It also subtracts costs like property insurance, maintenance services, and utility charges. Capital expenses, like a new air-conditioning system for the entire building, are not included.
Investors and lenders evaluate NOI to see whether a property's income will cover its debt and operating expenses. It is an important metric for comparing properties in the market and deciding which ones to buy or lease. It can also help investors and lenders determine the appropriate loan amount for a property. To improve a property's NOI, owners can raise rental rates or reduce costs. They can also hire a management company to handle some of the property's functions and services.