Net Operating Income is the potential profit of a real estate investment. It is used to determine the value of a piece of real estate that has rental income. Calculating the Net Operating Income is typically performed by sellers to determine a fair list price and it is used by buyers to calculate a suitable offer when considering a purchase.
The actual calculation seems simple at first. Basically you are subtracting the Operating Expenses of the property from the Gross Revenue that is generated by the real estate. Once you have done that, you have your Net Operating Income.
Gross Revenue
When looking at a rental property, there are the actual rents the property brings in. Also there may be a number of other incomes sources such as parking, laundry, vending and late fees. After all of these figures have been totaled, you will have a positive number that constitutes the Gross Revenue generated by the property.
Operating Expenses
The Operating Expenses are the costs it actually takes to operate the building on an annual basis. Capital improvements made to a property should not be included in the Operating Expenses. This is because major improvements such as putting in a new sidewalk is not something that needs to be done every year. The company hired to shovel the snow from the sidewalk every winter is an Operating Expense though. The owner’s mortgage should not be included in the Operating Expenses of the property either. This is an owner expense and not an Operating Expense of the building. The next owner could be a cash buyer so the current owner’s mortgage amount is not a valid expense to him. Therefore, the Operating Expenses are the reoccurring expenses of the property only.
Determining the Net Operating Income of a rental property is the ideal way to determine the value of an investment property. Understanding all of the figures can be difficult for even an experienced investor. Therefore, it is recommended that an investor speak to an accountant or to a real estate agent to insure their calculations are correct and they are getting the best deal on their investment property!