Let’s Make Sense of Net Operating Income

Net Operating Income (NOI) is an essential part of your business to understand. Once you’ve been doing it for a while it starts to seem so simple, that I catch myself just using it in these articles without giving a good explanation. This article will tell you all about the NOI. If you already grasp this metric, feel free to move to the next article.

So, you made it through the first year owning your new property (or business). Well, your property is really the same thing as a business, and you need to think of it that way. In the first year you took in a bunch of money and you paid out a bunch of money. Let’s look at a simple 8-unit building which we will call SunnySide Apartments. We’ll generate a very basic Profit and Loss statement and discuss it.

SunnySide Apartments Profit and Loss
Income
Rent $    96,000.00
Laundry $      1,000.00
Late Fee $          100.00
Garage $      4,800.00
 $  101,900.00
Expenses
Property Tax $      8,000.00
Insurance $      8,000.00
Utilities $      1,000.00
Bad Debt $                   –  
Repairs and Maintenance $      5,000.00
Management $      8,000.00
 $    30,000.00
Net Operating Income $    71,900.00
Debt Service $    50,000.00
Capital Expenditure $      5,000.00
Investor Dividend $      1,000.00
Cash Flow $    15,900.00

SunnySide was purchased on January 1 and you immediately took control. Over the course of the year, you took in rent of $1,000 per unit every month. Multiplied by 8 units over 12 months that gave you 96k income. This building has coin-operated laundry and brought in 1k. You also took in some late fees and had garages all rented at $50 a month. This amazing property had no vacancy over the year, but the profit and loss statement already accounts for this because it is giving you the actuals, not the projection. If you took in less rent due to vacancy or nonpayment of rent, you simply put the amount received into the spreadsheet.

Income on a rental property will only have a few lines because there aren’t very many income streams. Some properties will have income from utility agreements or utility bill-backs, but that’s about it.

Expenses will be a bit longer. The one above is really simplified. This doesn’t represent an actual property, in fact, it’s a pretty nice one for only 8 units. You don’t know how much it was purchased for, which would be important if you were trying to make calculations about how well it is performing, but that’s not important right now. The biggest thing that doesn’t go into expenses is the payment of mortgage. This is always a tough one to wrap your head around because it is an expense. We discussed the reason back in the Capitalization Rate. I’m sure there is another good accounting reason, but I’m not an accountant.

Once you’ve calculated all your operating income and expenses, you subtract the expenses from income and you are left with the Net Operating Income. You’ll often times hear that NOI is ‘before tax’, which can be confusing. It is after property tax, but before income tax (which doesn’t show up on the above spreadsheet for simplicity). Income tax is tricky because it will be different for everybody and is individualized. Most small or medium real estate projects will utilize pass-through taxation, which means the business itself doesn’t pay taxes, but the tax liability is passed through to the owners to report on their individual tax returns. It is left to the owners to calculate this into their own investment calculations.

Remember NOI is Net Operating Income, so it takes into account only the regular operations of the property. Irregular expenses such as Capital Expenditure and Investor Dividends are taken out after NOI is calculated.

Familiarize yourself with the NOI; it’s one of the basic building blocks to evaluating your deals.

Dr. Equity

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