This week, I'm going to be answering one of the questions that I get asked most frequently, and that is: what is NOI? Feel free to follow along with the video below if you would like!
What is It Exactly?
NOI stands for 'Net Operating Income', and that is the annual revenue on an investment property minus all of the annual operating expenses such as utilities, insurance, maintenance, and repairs. Usually, you will see these operating expenses collectively referred to as 'OpEx'. See formula below:
The NOI as we'll refer to it as hereafter is really useful as an investor when determining the merit of a property as a potential real estate investment vehicle. I like to look at the NOI on both a monthly and an annual basis for different reasons that we will dive into and discuss further in the coming weeks. Understanding NOI as early as possible in our investing journey is important as we will come across it frequently when looking at property listings (especially for real estate investment focused sites) online.
Whether you came from BiggerPockets and have seen the term thrown around on the online investing forums, or you have been listening to Meet Kevin and Graham Stephan on YouTube talking about real estate investing, you have definitely heard the term and might not have fully understood it until now.
Hopefully this has provided some additional clarity on what net operating income is, and how it is calculated. It will be integral moving forward and be incredibly useful when determining how much a property is worth, what your maximum offer can be, and how much you can expect to sell your own real estate investments for when you decide to list them for sale.
Determining Property Value with NOI
When determining how much a property is worth using NOI, it is important to also understand how it relates to capitalization rates (cap rates) and purchase prices. If you are not familiar with what a cap rate is, please check out my other blog post where we dive deeper into cap rates and how they are useful in real estate investing!
If you able to glean the net operating income of the property and are familiar with what similar properties are trading at in terms of capitalization rates, you can then determine a range in which you could reasonably expect the property to trade in.
For example, let's say you find a property that you are interested in purchasing and request more information from the broker. Once they send you the last 12 months worth of financial information in the form of rent rolls and profit and loss statements (referred to as the T12), you can find the annual net operating income for the previous year and divide it by the average trading cap rate for similar properties in the area (similar in size, condition, asset type, etc.) to determine what the property is worth on the market. I always recommend calculating with a 1.0% tail on either end of your estimated cap rate in order to give yourself a reasonable range at which you can run your numbers to determine whether or not it is a feasible real estate investment.
This is also a great way to determine how much you should sell your real estate investments for when it comes time to sell so that you can pull the equity built over the years out and redeploy it in other investments. As always, feel free to reach out with any questions or comments, and let me know what else you want to learn more about!
