Net Operating Income
Net Operating Income (NOI) is the single most important measurement in commercial real estate. Whether you have a single family residence that you rent out, or a ten story high rise, Net Operating Income (NOI) is the amount of income that goes to the owner of the property after expenses are deducted from income, but before debt service or income taxes are considered.
NOI is important in analyzing properties because it is used directly or indirectly in some key formulas. Formulas such as Cap Rate, Cash Return on Investment, Total Return on Investment, and Debt Service Coverage Ratio all use NOI in some form or fashion. It is not only used in establishing value, but also in building strategies to increase value.
The NOI is calculated as follows:
NOI = GOI – Expenses, where GOI is the Gross Operating Income of the commercial real estate asset. Expenses include property taxes, insurance, maintenance, utilities, capital reserves, management fees and incidental expenses. NOI is analogous to a simple profit calculation for a business.
The commercial property’s Gross Operating Income (GOI) is needed for the NOI calculation. The GOI is determined by subtracting the vacancy rate reserve from the Scheduled Gross Income (SGI). This is done to adjust the SGI for tenant vacancies. The SGI is simply the total amount of rents scheduled to be collected annually.
An investor (buyer) typically obtains the necessary financial information by requesting it from the seller or the seller’s agent prior to executing a commercial real estate sale transaction.
It is customary that the sale transaction purchase contract sets forth the details by which the buyer and his agent verifies or determines a NOI and other important components of his financial analysis by his own due diligence work, while in escrow.