December 17, 2024

Net Operating Income In Commercial Real Estate

Understanding net operating income (NOI) in commercial real estate is crucial to growing your investment portfolio because it measures the profit you can earn if you purchase a particular property. By partnering with a commercial real estate firm with an in-depth understanding of the local market conditions, you can easily calculate the NOI on a property you are considering purchasing and determine if it’s the right addition to your portfolio.

What is Net Operating Income?

Net operating income is a standard calculation used by real estate investors and property owners to determine how much revenue can be generated from an individual property. It’s important to note that NOI is calculated before taxes or other financing costs. This calculation also does not include any capital expenditures.

Ultimately, a property owner will rely on the NOI metric to determine if the purchase will be a worthwhile investment in the long term. They will also calculate the NOI to verify that the potential income will outweigh the cost of maintaining the property throughout its lifespan.

How to Calculate the NOI

Calculating the NOI is very simple. This formula involves determining the operating revenue of a property and then subtracting the operating expense.

For instance, you may be considering purchasing an office space that can be rented to two tenants. If the office space can generate an income of about $150,000 but has expenses that total $65,000, the NOI on this property would be $85,000.

It is a quick and effective way to decide if a property is worth pursuing. However, if you are questioning your ability to determine an accurate NOI, you should consult a commercial real estate firm to evaluate your options.

How to Increase the Net Operating Income

It’s worth noting that the NOI is not necessarily a stagnant number. As a commercial real estate investor, there are steps you can take to grow and improve your net operating income over time. These are a few tips to help you increase your NOI:

• Reduce your vacancy rate. Ensuring that reliable tenants occupy all available spaces in your building will generate the maximum possible income and increase your NOI.
• Increase your rental costs. In some cases, it may be necessary to raise the cost of rent for your tenants to maintain or improve your NOI. Make sure you evaluate current market conditions and cost of living before you make this decision.
• Adding new revenue streams. For instance, you can install vending machines in the building as a simple way to increase cash flow and boost your NOI.
• Reduce your operating expenses. One of the best ways to do this is to lower your utility costs. You can do this by optimizing the equipment that you have in your building and investing in sustainable technology.
• Reduce your insurance costs. If the insurance rates for your building have increased over time, it may be time to start looking at different policies and providers.

How is NOI Used in Commercial Real Estate?

In commercial real estate, it is essential to be aware of your NOI and make an effort to improve it over time. As a property owner with multiple rental properties, you must generate enough income to cover your mortgage payments, maintenance costs, and more. You also want to have enough capital to reinvest in your properties so you can attract the best tenants and improve the value of your property over time.

The NOI plays a pivotal role in determining the capitalization rate of your property. Your cap rate is calculated by dividing the NOI by the cost of your property. Ultimately, when you have a higher NOI, you will see a better return on your investment because your building will have a higher property value.

What’s Not Included in Net Operating Income

Knowing what is not included in the net operating income metric is just as important as understanding what is. Here is what’s not included in NOI:

• Principal and interest payments on any outstanding loans
• Capital expenditures
• Depreciation
• Amortization

An Example of Net Operating Income

This example will help you understand how easy calculating a property’s NOI is. Imagine that you are about to buy a retail space to house a local business. You would calculate the NOI by determining the operating expenses and subtracting that from the operating revenue like this:

Retail Commercial Building Operating Revenue

• Rental income: $75,000
• Additional Fees: $5,000
• Total Operating Revenue: $80,000

Retail Commercial Building Operating Expenses

• Property Taxes: $7,000
• Property Management Fees: $1,500
• Maintenance Costs: $5,000
• Insurance: $2,000
• Total Operating Expenses: $15,500

To calculate the NOI, you take your $80,000 in revenue and subtract $15,500 in expenses, so your net operating income is $64,500.

Analyzing NOI Alongside Other Key Deal Metrics

While the NOI is a critical metric in determining whether to purchase a commercial property, using it alongside other metrics is essential to understand how this property will perform. Other key metrics to consider besides the NOI include the debt service coverage ratio and cash flow metric.

Remember that your NOI provides an at-a-glance glimpse of the potential income for a given property, but it can change over time. You will want to keep comparing your NOI to other critical financial metrics to evaluate the value of your property and the health of your investment portfolio.

Build Your Portfolio with Commercial Rental Properties Today

At RakowGroup, we proudly assist our clients with their commercial real estate needs. Our commercial realty services can help you grow your real estate investment portfolio and maximize your return on investment. For more information about our property management services and the types of commercial leases available, contact us today.