NUTS & BOLTS
ACCOUNTING
It Pays to Know ‘NOI’ NET OPERATING INCOME IS AT THE HEART OF MANY CALCULATIONS VITAL TO DETERMINING INVESTMENT PROFITABILITY.
by Carter Froelich, CPA
n previous articles, I have discussed how to estimate effective gross income and operating expenses. With those figures at hand, we can now estimate our property’s net operating income (NOI). NOI is calculated as follows: I
GROSS SCHEDULED RENTS + OTHER INCOME - VACANCY ALLOWANCE
= EFFECTIVE GROSS RENT - OPERATING EXPENSES
Gross scheduled rents Plus other income
Minus vacancy allowance Equals effective gross rent Minus operating expenses Equals net operating income
= NET OPERATING INCOME
NOI represents the amount of funds the property is expected to produce after the payment of normal operating expenses. Mortgage payments, capital improvements and depreciation are not part of the calculation of NOI.
WHY IS NOI IMPORTANT? We have spent the last several articles explaining the steps required to estimate a property’s NOI. Why, you may ask, is the estimation of a property’s NOI so important? For starters, real estate investors are not purchasing an asset. They are purchasing an income stream, and the NOI is the main component of that income stream. If you think this is a crazy idea, when was the last time you purchased a stock for the look of the stock certificate? The answer is “never.” You purchased the stock for the anticipated economic benefits that the company stock would provide over time. The same is true for real estate investing. NOI represents the return that the investor will receive on his or her investment if purchasing the property utilizing a 100 per- cent cash purchase. For instance, if a property’s NOI is $10,000
106 | think realty magazine july :: august 2016
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