Understanding Net Operating Income

|Understanding Net Operating Income

Understanding Net Operating Income

The first question out of my mouth when someone is presenting a deal to me is:

“What’s the current net operating income (NOI)?”

Net operating income is the amount of income a property is throwing off after all expenses like taxes, insurance, utilities, and maintenance, but before debt service.

The reason we do not initially look at post debt service cash flow is because the capital stack on each deal is different. Someone may purchase a building all cash. Another investor may use 100% debt financing. Others may be somewhere in the middle. The point is every deal and every investor is different. NOI is the universal starting point that shows investors how much operating income a property is throwing off. The true value of the asset in the marketplace is derived from its NOI.

As value add investors, current net operating income is an important metric we evaluate when analyzing a property, but it does not tell the whole story. What is even more important is how much we can increase the NOI of a particular asset through our own doing.

Additionally, NOI alone does not tell you the current value of an asset. $500,000 in NOI looks very different on a $5mm deal versus a $25mm deal.

Let’s talk Cap Rate next time, so you can understand how all commercial real estate is valued in the marketplace.