Please ensure Javascript is enabled for purposes of website accessibility

What Is Net Operating Income?

By Motley Fool Staff – Jul 15, 2016 at 11:08PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Not all real estate investments are worthwhile. Net operating income is a strong indication of a property's revenue-generating ability.

Some people buy property for their own personal use. Others, however, buy real estate as an investment. Net operating income is a measure of a real estate investment's profitability. To calculate net operating income, or NOI, we take the property's revenue, and subtract all reasonable operating expenses.

IMAGE SOURCE: GETTY IMAGES.

Understanding net operating income

Net operating income is a stronger indicator as to whether a real-estate investment is profitable, or has the potential to be profitable. NOI is reported on income and cash flow statements, and examines the cash flows of an investment property before factors like financing costs and taxes are taken into the equation.

If a property's total revenue over a given period is $200,000, and its operating expenses equal $100,000, then its net operating income is $100,000. Ideally, a property's net operating income should be positive. If the total is negative, it becomes a net operating loss.

There are several ways for a property to generate revenue. These include:

  • Monthly rent payments from tenants
  • Common area rentals from tenants or outside individuals
  • Proceeds from on-site laundry facilities
  • Proceeds from on-site vending machines
  • Proceeds from on-site parking facilities

Similarly, there are numerous operating expenses that go into running a property. These include:

  • Routine maintenance costs, such as lawn care and snow removal
  • Property repair costs
  • Superintendent, doorman, and office staff salaries
  • Property management fees
  • Janitorial expenses
  • Real estate taxes
  • Utility costs not directly passed on to tenants

Uses of net operating income

Net operating income is a strong measure of a property's ability to generate income. The NOI calculation excludes figures such as income taxes or financing costs. Rather, it shows how much revenue a given property can generate on its own.

Net operating income is considered an accurate measure of a property's potential because it is less subject to manipulation than other figures. NOI can typically only be increased by raising rents, increasing the cost to use on-site facilities like laundry and parking, or finding lower-cost options for maintenance and repairs.

Net operating income is essential in helping investors determine a property's capitalization rate, which is the rate of return on an investment property based on the income that it's expected to generate. As such, NOI can help an investor compare different properties to see which has the most potential. It can also be useful for an investor who owns several properties and is looking to unload the one whose operating costs leave the least amount of room for profit.

Net operating income also comes into play when properties need to be financed. Specifically, NOI is used to calculate a property's debt coverage ratio, which measures its ability to pay its debt based on its cash flow. Since NOI shows how much income a property can generate based on how much it costs to keep it running, it's a helpful tool for lenders and investors alike. 

This article is part of The Motley Fool's Knowledge Center, which was created based on the collected wisdom of a fantastic community of investors. We'd love to hear your questions, thoughts, and opinions on the Knowledge Center, in general, or this page, in particular. Your input will help us help the world invest, better! Email us at [email protected]. Thanks -- and Fool on!

Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

HOW THE MOTLEY FOOL CAN HELP YOU

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
327%
 
S&P 500 Returns
105%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 09/27/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.