Real Estate (Net Operating Income & Net Operating Loss)
Investing in real estate is somewhat like investing in stocks. To profit, investors must analyse and evaluate real estate to make educated guesses about how much profit each will make, whether through property appreciation, rental income, or both. That's where NOI comes.
Net operating income is a measure of a real estate investment's profitability. To calculate net operating income or NOI, the investor should take all revenue from the property and subtract all reasonably necessary operating expenses.
NOI is a before-tax figure, appearing on a property’s income and cash flow statement, that excludes principal and interest payments on loans, capital expenditures, depreciation, and amortization.
Net operating income is a valuation method used by real estate professionals to determine the precise value of their income-producing properties.
For example, an investor owns a property where NOI or NOL can be determined by following
Operating income = Gross income – Operating Expenses
Annual Gross Revenue or Income = $100,000
Annual Operating Expenses = $60,000
If the total is positive then it net operating income (NOI)
If the total is negative, where operating expenses are higher than revenues, the result is called a net operating loss (NOL).
Net operating income is essential in helping investors determine a property's capitalization rate, which is the rate of return on an investment property based on the income that it's expected to generate. As such, NOI can help an investor compare different properties to see which has the most potential. It can also be useful for an investor who owns several properties and is looking to unload those where operating costs leave the least amount of room for profit.
Net operating income also comes into play when properties need to be financed. Specifically, NOI is used to calculate a property's debt coverage ratio, which measures its ability to pay its debt based on its cash flow. Since NOI shows how much income a property can generate based on how much it costs to keep it running, it's a helpful tool for lenders and investors alike.