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Get The Most of Your Property – Net Operating Income

Posted by Steve on January 8, 2024

Net Operating Income (NOI) serves as a crucial economic metric, evaluating the profitability of real estate investments that yield returns. This figure, calculated pre-tax, is integral to a property’s income and cash flow statement. In the following section, we aim to elucidate the computation of net operating income, its definition, and components.

**What is Net Operating Income (NOI)?**
Net Operating Income (NOI) is determined by deducting all operational expenses from a property’s income, encompassing not just rent but also additional sources like parking fees. Operational expenses include insurance, legal fees, utilities, property taxes, maintenance, and cleaning. Notably, NOI excludes considerations like loan payments, interest, significant expenditures, or certain financial concepts. In other realms, it aligns with “EBIT” (Earnings Before Interest and Taxes), making it applicable beyond real estate. Additionally, NOI calculates key figures such as earned income, cash return from investment, and expected total return.

**Income Generated by Property:**
To illustrate, assume you own a rental property in Thailand. Income generated includes various streams:

– Rental income: Monthly rent collected from tenants.
– Parking fees: Revenue earned from parking spaces provided to renters.
– Laundry facilities: Income generated from coin-operated laundry facilities.

**Operating Expenses for Property:**
Conversely, operating expenses encompass vital costs essential for property functionality and maintenance:

– Property management fees: Compensation for managing and overseeing the property.
– Utilities: Costs for electricity, water, gas, and other essential services.
– Maintenance and repairs: Funds allocated for routine maintenance and unexpected repairs.
– Property Taxes: Annual tax imposed by local authorities on the property’s value.
– Premium insurance: Insurance covering potential risks and liabilities.
– Landscaping and Groundskeeping: Costs for maintaining the property’s exterior appearance.
– Marketing and advertising: Expenses for promoting the property and attracting tenants.

**How to Use Net Operating Formula:**
Understanding the foundational formula, the Net Operating Income formula is crucial for calculating its application. The formula reads as follows:

\[ \text{Net Operating Income (NOI)} = \text{Total Real Estate Revenue} – \text{Operating Expenses} \]

“Total Real Estate Revenue” includes all income sources, comprising rent and passive income such as parking fees. Conversely, “Operating Expenses” cover operational costs like maintenance, utilities, and property taxes, with significant capital expenses excluded.

**How to Calculate Net Operating Income:**
Calculating the Net Operating Income formula is vital in real estate investing. This necessitates an understanding of “gross income” and “net income,” foundational concepts in NOI comprehension.

– Gross Income: A property’s overall income before accounting for any expenses or deductions.
– Net Income: The income after subtracting all operational expenses from the total revenue.

Net Operating Income (NOI) stands apart from gross operating income in real estate, as it indicates the total potential income from a property, factoring in vacancy-related income loss.

To exemplify, consider a villa at Kata Top View in Karon Beach (Phuket) with three bedrooms and a monthly rent of 60,000 baht. Applying the Net Operating Income formula:

\[ \text{Rental income} = 60,000 \, \text{baht per month (720,000 baht per year)} \]
\[ \text{Other income} = 10,000 \, \text{baht per year (assumed)} \]
\[ \text{Operating expenses} = \text{Sum of property management fees, insurance premiums, property taxes, utilities, maintenance, and miscellaneous fees} \]

Similar calculations can be performed for another example, such as a villa at Mali Status in Hua Hin.

**What is Gross Operating Income?**
In the real estate industry, gross income represents the ultimate income within a specific time frame after subtracting the cost of goods sold (COGS) from total revenue. This applies whether the business involves tangible property sales or service provision. For service-oriented real estate investments, the costs associated with those services are subtracted, similar to costs in manufacturing or purchasing goods.

**What is Included in Gross Operating Income?**
Gross operating income calculates all revenue streams that a property generates, including not only rent but also additional income sources like fees for amenities, parking, and other related property income. The formula for Gross Operating Income (GOI) is:

\[ \text{Gross Operating Income} = \text{Rental income} + \text{Other income} \]

**What are Operating Expenses?**
Operating expenses in real estate encompass various costs that arise daily in managing your property. These costs are crucial elements of owning and managing a property and impact its financial performance. Types of operating expenses include:

– Maintenance and repairs: Regular maintenance, repairs, and significant renovations for optimal property condition.
– Utilities: Costs related to essential services like water, electricity, gas, and waste removal.
– Property management fees: Compensation for professional property management services, covering administrative tasks, tenant interactions, and overseeing property maintenance.
– Insurance premiums: Payments for insurance coverage safeguarding the property against potential risks and liabilities.
– Property Taxes: Taxes levied by local authorities on the property’s value, contributing to community infrastructure and services.
– Cleaning services: Costs associated with maintaining cleanliness and hygiene on the property’s premises.
– Landscaping and Groundskeeping: Expenses incurred for maintaining lawns, gardens, outdoor areas, and overall landscape aesthetics.
– Security: Costs linked to security measures and systems, including surveillance cameras, alarm systems, and security personnel.
– Administrative costs: Administrative fees like accounting, legal fees, and property management software costs.

**Net Operating Income Pros and Cons:**

1. **Accurate Valuation:** Provides a precise metric for valuing income-producing properties.
2. **Reflects Operational Performance:** Factors in operational expenses, revealing how efficiently a property is managed.
3. **Useful for Investment Decision:** Allows investors to assess potential returns and make informed investment decisions.
4. **Assists in Rental Pricing:** Helps determine optimal rental pricing for desired profitability.
5. **Simplified Calculation:** Calculating NOI is straightforward, using income and operating cost figures.

1. **Limited for Investment Comparison:** While crucial for a single property’s assessment, it may not provide a direct basis for comparing multiple properties.
2. **Excludes Financing Costs:** The formula excludes financing-related costs, potentially impacting the assessment of overall profitability.
3. **Ignores Property Financing:** Financing terms can significantly affect the property’s financial health, and NOI does not account for this factor.
4. **Ignores Tax Impact:** Property tax variations are not directly factored into the NOI method.
5. **Ignores Market Fluctuations:** The method does not account for external market forces that could impact property value.

**Frequently Asked Questions (FAQs):**

**Q: Is NOI the same as the Gross Income calculation?**
A: No, Net Operating Income (NOI) and Gross Income calculation are separate concepts. NOI indicates the total revenue a property generates after deducting operating expenses, offering insights into its financial performance. In contrast, gross income calculation involves subtracting the cost of goods sold (COGS) from total revenue, typically used in business to assess profitability.

**Q: Is EBITA the same as NOI?**
A: No, EBITA (Earnings Before Interest, Taxes, and Amortization) and NOI are not equivalent.

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