Sometimes listening to apartment investors is like listening to another language. And if you aren’t familiar, it can sound a lot like Charlie Brown’s teacher: whaa, whaa, whaa, whaa, whaa. We’ll eliminate the NOI “whaa” in this blog and turn it into a useful part of language.
The term NOI (pronounced “N.O.I”), is a short for net operating income. And net operating income can be a very important consideration when evaluating a potential investment.
What NOI is not
NOI is not the only measure of the value of a particular asset. Commercial multifamily assets can be valued using a variety of measures, examples of which are per unit pricing or gross rent multiplier.
NOI is not the only measure of the health of an asset. Certainly NOI plays a very important role in this capacity, but not as a standalone indicator. It is therefore incumbent on the investor to put all of the pieces of the financial health puzzle together before and during their investment.
NOI: the definition
Net operating income is one measure of the financial health of an apartment asset. Additionally, the valuation of an asset depends on net operating income.
A building that is generating revenue and expenses will be able to create a meaningful net operating income. It’s worth noting that assets without revenue will end up with a negative net operating income.
After all of the buildup, you quite likely will find the actual calculation quite simple. Net operating income is the total revenue of an asset minus its total expenses.
An example might look something like this:
Using our very simple formula, our net operating income is $400,000.
NOI Calculation Exclusions
Some folks might feel compelled to include everything in their expense lines. Some common mistakes with this calculation are:
1. Including financing payments. No interest payments or principal pay down are part of the net operating income calculation. These payments are “below the line” deductions and are not part of the net operating income definition.
2. Including capital expenditures. Some expenses an asset incurs are not technically classified as expenses, but rather capital expenditures. While it is beyond the scope of this blog to go into the differences, suffice it to say that attention should be paid to these categorizations when attempting to reach a definitive net operating income.
Compared to some of the more technically heavy calculations around investment returns, NOI can seem comparatively easy to compute. And while functionally this is true, net operating income contains nuances. As you might expect, any misplaced data that becomes part of the inputs will have a direct impact on your NOI output and perhaps consequently, your investment.Tags: Apartment Investing Terms, commercial real estate investing, net operating income, NOI