Net Operating Income Formula
The Net Operating Income (NOI) is one of the most important figures when analyzing the profitability of commercial property investment. It is calculated as the difference between the property’s rental income and its operating expenses, which are specifically listed in the spreadsheet below. It is used to calculate the before-tax-cash flow by deducting the mortgage payment, which depends on the term of the loan and the mortgage rate.
The major reason for the importance of the NOI in property investment analysis is that one of the major methods used by industry professionals to determine the value of commercial property is the income capitalization approach, according to which the value of an income producing property is equal to:
Value = Net Operating Income / Market Cap Rate
Thus, if the Net Operating Income of a commercial property and the market capitalization rate that can be reasonably applied to it (given its characteristics) is known, it can allow for a quick and rough estimate of the market value of the property.
lThe NOI is also necessary for the calculation of Debt Coverage Ratio or DCR for property investment properties, which provides to mortgage lenders and investors a measure of the ability of a commercial property to cover both it’s operating expenses and mortgage payments.
The Net Operating Income is also a critical part of the Income Statement, Cash Flow Statement and return calculations for a commercial property. In particular, it is important in estimating the Net Income Multiplier, and the internal rate of return (IRR) of a commercial property investment.