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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.
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Income |
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Gross Rents Possible |
100,000 |
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Other Income |
3,000 |
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Potential Gross Income |
103,000 |
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Less vacancy Amount |
2,000 |
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Effective Gross Income |
101,000 |
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Less Operating Expenses |
31,000 |
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Net Operating Income |
70,000 |
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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. |
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Net Operating Income 50,000 |
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Estimated Value = ------------------------------ = ------------ = 500,000 |
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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. |
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Net Operating Income 50,000 |
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Debt Coverage Ratio = ------------------------------- = ----------
= 1.25 |
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Debt Service 40,000 |
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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. |
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The Net Operating Income is an important ingredient in
several real estate ratios which include the Capitalization Rate,
Net Income Multiplier and the Debt Service Coverage Ratio. It
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.
© Copyright 2000 - 2010 Advantage Software LLC |
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