Net Operating Income and Real Estate

Real estate net operating income is basically the difference between total income received from rental income after the deduction of all operating expenditure which may include insurance fees, management expenses and maintenance costs among others. All incomes are taken into considerations and all expenses deducted.

The real estate net operating income is mainly used in calculating two very important real estate ratios. It is a very essential figure when calculating the capitalization rate which in essence is used to find out the sale value of a property. The value of income generating real estate properties is calculated by dividing the net operating income by the capitalisation rate.

The importance of real estate net operating income cannot be underestimated since it forms the basis of calculating the debt coverage ratio which is an objective measure of the ability of an asset to pay its mortgage and operating expenses when required. The ratio of 1 indicates breakeven while a higher ratio is more acceptable. For instance, you need to have a minimum of 1.1 if you are applying for a commercial loan. Real estate analysts use net operating income to determine the level of profitability in real estate investment.

When given two cases where the first one is that the investor pays all cash for the property. Hence no debt is incurred. When there is no loan repayment, the annual cash inflow is regarded as the net operating income. The second case is where a financier provides the funds or purchasing the property. Given the circumstance, the real estate operating income is the amount of the money available to service the debt and then the cash flow only after the applicable loans.

Calculating Net Operating Income

Net operating income plus operating expenses equals to net operating income.

For example, let's assume you are analyzing an apartment building that produces a gross operating income of $200,000 and operating expenses of $52,000. What is the Net operating income?

This should be: $200,000 less $52,000 equals $58,000.

Capitalization rate, for instance, is calculated by dividing NOI by sale price, and property value is calculated by dividing NOI by capitalization rate.

Net operating income also plays a large role with lenders. Debt coverage ratio (or DCR), for instance, is calculated by dividing the net operating income by annual loan payment.

How credible is real estate net operating income? The figures used together with the corresponding accuracy of the person doing the analysis can affect the results by a great extend. With care and the necessary skill, correct figures can be obtained hence adding value to decision making process.

Generally, real estate net operating income is used as an aid to decision making. The property sellers, buyers, financiers and other related parties use it when evaluating the existing option in the real estate business. Given the great importance, it is imperative that the correct figures are used to avoid misleading since costly decisions will be made based on the results obtained.

Ottawa Real Estate agent in Ottawa, Ontario with HomeLife Capital Realty Inc., Brokerage