Net operating income is what a property earns from operations in a year: all collected income minus operating expenses, before any mortgage payment, income tax, or capital projects. It is the number the building itself produces, independent of how the owner financed it. Nearly every valuation conversation in income real estate is, underneath, an argument about the true NOI.
NOI=Effective gross income (EGI) − Operating expenses (OpEx)
EGI=Gross potential rent + Other income − Vacancy and credit loss
- Gross potential rent
- Every unit at its lease rate for twelve months, occupied or not.
- Vacancy and credit loss
- Months without a paying tenant, plus rent billed and never collected.
- Operating expenses (OpEx)
- Taxes, insurance, utilities, repairs, and management. Not the mortgage, income tax, depreciation, or capital projects.
- The building's own number. It does not change whether the buyer pays cash or borrows to the ceiling.
- Blind to capital. A roof or a plumbing stack never touches NOI and can consume a year of it.
- One dollar of NOI moves value by roughly sixteen at a 6% cap. That is why this line gets dressed.
- Rebuild the seller's NOI with real insurance, real management, and real vacancy before pricing anything.
The same eight units, one year of operations.
Two lines do most of the damage: taxes reset to the new price on the day of sale, and insurance is never the number the last owner paid. The tax line also cannot be filled in before the answer, and that trips most proformas. Carry 2% of the $2,000,000 asking price, $40,000, and the income comes to $87,960, which values the building at $1,466,000, a price at which nobody would ever owe $40,000. The bill follows what the buyer actually pays, so the line and the price have to settle together: at $1,599,500 the tax is $31,990, the income is $95,970, and the value that produces is the value the tax was calculated on. Breaking the loop in the wrong place costs $133,500 here, and it costs it against the seller.
Related terms
All termsCap Rate (Capitalization Rate)
The capitalization rate is a building's net operating income divided by its price, expressed as a percentage.
FinanceCash Flow
Cash flow is what actually lands in the owner's pocket in a period: net operating income minus the mortgage payment and minus the capital dollars the building consumed.
InvestmentProforma
A proforma is the projected income and expense statement for a property: what the next owner is being asked to believe.
Terms arrive with the writing.
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