Moody's CRE | The Nuances of Calculating Net Operating Income (NOI) (2024)

FAQs

Moody's CRE | The Nuances of Calculating Net Operating Income (NOI)? ›

Net Operating Income reflects the profitability of any income-generating property. It subtracts all operating expenses from the EGI, or effective gross income that an income-generating property produces. NOI for a property is intended to reflect the ongoing revenue and expenses for the property.

NOI is calculated by subtracting all operating expenses a property incurs from the revenue it generates. The NOI of a real estate property is typically included on its cash flow and income statements.

Net Operating Income Approach

This theory says that the WACC cost of capital will be constant if the company takes on more debt. The increased debt increases shareholders' risk, which raises the cost of equity. That increase in the cost of equity cancels out the cheaper cost of debt.

To calculate NOI, subtract all operating expenses incurred on a property from all revenue generated. NOI helps a property owner determine if renting a property is worth the expense of owning and maintaining it.

Net income is the total income generated by a property after deducting all expenses, including financing costs. On the other hand, NOI provides a more accurate picture of a property's profitability as it takes into account the property's operating expenses and cash flow.

The formula to derive the profits made from a revenue making property and to employ the net operating income calculator is: NOI Formula = Operating Revenue - Operating Expense. NOI Formula = Operating Revenue - COGS - SG&A.

For most business entities, a net operating income percentage of 20% or more is considered good. However, this number can vary depending on the industry and other factors. For example, a net operating income percentage of 30% or more would be considered excellent for retail property.

NOI, a pre-tax indicator featured on a property's income and cash flow statement, doesn't include loan payments, capital expenses, depreciation, or amortization. In industries beyond real estate, this metric aligns with “EBIT,” representing “earnings before interest and taxes.”

The net operating income line is calculated by deducting vacancy and credit loss from potential gross income, then subtracting out all operating expenses. Notice that the debt service and replacement reserves are not included in the NOI calculation.

A healthy profit margin is generally tied to revenue growth. Historically speaking, when the NOI profit margin is at 55.4% or higher, revenue growth at the national level has averaged 4.0%. However, when the NOI profit margin is less than 55.4% average, revenue growth slows to 0.9%.

What is the difference between operating income and net operating income? ›

Operating income is revenue less any operating expenses, while net income is operating income less any other non-operating expenses, such as interest and taxes. Operating expenses include selling, general & administrative expenses (SG&A), and depreciation and amortization.

NOI is primarily used to evaluate the profitability of an investment in a commercial or residential real estate property. EBITDA, on the other hand, is primarily used to evaluate the profitability of a company. As a result, NOI takes into account lost revenues from vacancies, whereas EBITDA does not.

Property Taxes: While income tax isn't included in the NOI formula, property taxes are considered an operating expense. With commercial properties, these can be significant and can see dramatic increases, especially in municipalities that re-assess infrequently.

The NOI approach is based on following assumptions: (i) There are no corporate taxes. (ii) Cost of debt remains constant at all level of debt. (iii)Overall cost of capital remains constant.

NOI serves as a foundational indicator of a property's financial health, offering insights into its operational efficiency and profitability. It is crucial in calculating the capitalization rate (cap rate), a metric used to estimate potential ROI and compare the attractiveness of different real estate investments.

Notably, the NOI metric neglects debt service payments, interest expense, capital expenditures (Capex), depreciation, and income taxes. EBITDA → The EBITDA metric is a widely-used measure of operating profitability used to analyze the operational performance of companies in most industries.

The NOI margin is a profitability ratio that measures the operating efficiency of a property and is calculated by dividing net operating income (NOI) by the total property revenue.

A relatively simple calculation, an investor can find out their cash-on-cash return by taking the pre-tax cash flow (determined using the income and expense calculations for a property) and dividing that figure by the total amount of cash invested. The resulting figure is the cash-on-cash return.