Net Operating Income No one invests without the thought of profit. It is in essence, like taking on a job. When you take on a job, you expect to get paid. In the case of an investment, your payment comes in the form of profit. It makes sense then that your success is measured based on your profit. This profitability measure, often also called the bottom line, is also more commonly referred to as the net operating income.
The calculation of net operating income is relatively simple but understanding the terms will make it less of a formula and more of a concept, so let’s start there.
If you think of your property as one big functioning piece of real estate then your ideal or preferred situation is going to be your property at peak occupancy, at the peak price within the market. This situation would mean you have maximized your investment. That is why this is called your gross potential income; it is the maximum income you could get for the property. Gross potential income is necessary to compute your NOI.
To compute for gross potential income, the formula is:
GPI (gross potential income) = gross potential rent (GPR) – (vacancy) – (loss to lease) – (bad debt) – (concessions)
To understand what these terms mean
- Vacancy for computation here is computed as the percentage units that are not occupied
- Loss to lease is any instance when a renter is paying less than what the market dictates so really, even if someone is renting the unit, it is still not at its full potential
- Bad debts here are subtracted from GPR because the bad debt refers to renters who do not pay
- Concessions, which are the last part of the GPI calculation are credits. These credits can be anything from rent adjustments to moving fees
So now that you have your GPI the next part of the NOI equation is your expenses. Expenses include but are not limited to the following. It's important that you look at these costs as annual and keep these computations among the non-variable costs
- Grounds or security services and other services such as pest control or lawn care. These are called contract services
- Utilities
- Administrative costs such as office supplies, furniture and so on
- Marketing costs which also includes marketing to find new tenants
Now that you have both the gross potential income and the expenses, the net operating income computation is easy enough to compute. The formula to compute the net operating income (NOI) is
Net operating income = (computed annual gross potential income based on the formula earlier)- (annual expenses based on the annual expenses as mentioned earlier) - (Debit Service more commonly known as Mortgage payments)
Understanding the profitability of your investment is something that you want to make sure you are checking and tracking. The health check of your investment is related to your profit and loss which also includes understanding your net operating income or your bottom line. Let us help you manage your Investments in our commercial multifamily portfolio and allocate your resources according to what works best for you.
