Advantage Software LLC What is Net Operating Income and How is it Calculated?
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    Net Operating Income
  Net operating income or NOI is equal to a property's yearly gross income less operating expenses.  Gross income includes both rental income and other income such as parking fees, laundry and vending receipts, etc.  All income associated with a property.  Operating expenses are costs incurred during the operation and  maintenance of a property.  They include repairs and maintenance, insurance, management fees, utilities, supplies, property taxes, etc.  The following are not operating expenses: principal and interest, capital expenditures, depreciation, income taxes, and amortization of loan points. Net operating income is calculated like this.  
    Gross Rents Possible 100,000
    Other Income     3,000
Potential Gross Income 103,000
    Less vacancy Amount     2,000
Effective Gross Income 101,000
    Less Operating Expenses   31,000
Net Operating Income   70,000
  Net operating income or NOI is used in two very important real estate ratios.  It is an essential ingredient in the capitalization rate (cap rate) calculation that is used to estimate the value of income producing properties.  Lets assume we have a market capitalization rate of 10 for the type of property we are considering purchasing.  A market cap rate is calculated by evaluating the financial data from current sales of similar income producing properties in a given market place.  We are evaluating a similar income property that is currently for sale with a net operating income of $50,000.  We would estimate the value of this property like this.  
                                                       Net Operating Income            50,000
                    Estimated Value  =  ------------------------------     =    ------------    =   500,000
                                                          Capitalization Rate                 .10
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  Another important ratio that is used to evaluate income producing properties is the Debt Coverage Ratio or DCR.  The NOI is a key ingredient in this important ratio also.  Lenders and investors use the debt coverage ratio to measure a property's ability to pay it's operating expenses and mortgage payments.  A debt coverage ratio of 1 is breakeven.  Most lenders require minimum of 1.1 to 1.3 to be considered for a commercial loan.  From a a bank's perspective, the larger the debt coverage ratio, the better.   Debt coverage ratio is calculated like this.  
                                                                 Net Operating Income           50,000
                     Debt Coverage Ratio  =  -------------------------------    =   ----------   =  1.25
                                                                        Debt Service                    40,000
  Debt service is the total of all interest and principal paid on a loan in a given year.   It is equal to the mortgage payment times 12 or the mortgage payments times 12 if you have multiple loans on a property.  

The net operating income or NOI is an important ingredient in several real estate ratios which include the capitalization rate, net income multiplier and the debt service coverage ratio.  The NOI is also an essential part of an income property's Income Statement and Cash Flow Statement.  It is therefore important to understand how the net operating income is calculated.  The On Target real estate software provides detailed reports to help you understand real estate concepts.   On Target generates about 12 line-by-line reports and many different graphics to assist the real estate investor.  In the Ratio Analysis report, with a click, you can view the formula for a ratio.  If you would like to learn more about On Target, click on   Software Features  .  The On Target real estate software includes a 30 day money back guarantee and free support.

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