April 7, 2022

Net Operating Income for Real Estate Investors: Why Does It Matter?

This key metric can help real estate investors make informed decisions and maximize their portfolio income.

Net Operating Income for Real Estate Investors: Why Does It Matter?

When building your real estate portfolio, it's important to understand the different metrics you'll use to measure success. Net operating income, or NOI, is one such metric; it's a measure of a property's cash flow and can help you determine whether a given real estate investment will be worth your time.

So, why does net operating income matter to investors? The short answer is that it allows you to make more informed investment decisions and maximize your portfolio income.

This article will explain what NOI is, how to calculate it, and why it's important for investors.

Let's get started!

What is Net Operating Income?

Calculating your total income is a useful metric, but it doesn't tell the whole story. You need to subtract the added expenses of renovation and maintenance, as well as property taxes and mortgage payments, to get a more accurate picture of your cash flow. This is where net operating income comes in.

NOI is the calculation of a property's total income minus its total expenses. In other words, it's the amount of cash flow you can expect to receive from a property each year. This metric is especially important for real estate investors, as it can help them determine whether a given investment is worth their time.

Calculating NOI

To calculate your property's NOI, simply subtract your total expenses from your total income. Here's an example rental property:

Annual Income: $10,000

Annual Expenses: $4,000

NOI: $6,000

This property generates an NOI of $6,000 per year, meaning it has a positive cash flow.

So, what does this tell the investor? With this calculation, they can expect to earn a return of $6,000 on their investment each year. Not only that, but it indicates that the property is generating more income than it costs to manage and maintain, making it a profitable investment.

Why is NOI important for real estate investors?

In real estate, there is a crucial metric called the capitalization rate, or "cap rate." This measures the percentage of a property's income that is actually profit. In other words, it calculates how much return an investor can expect on their investment.

Cap rate is calculated by dividing the NOI by the purchase price of the property. So, if you purchase a property for $100,000 and its NOI is $10,000, your cap rate would be 10%.

This metric is important for investors because it can help them determine whether a property will be a good investment. In general, the higher the cap rate, the more profitable the investment.

Because your NOI is a major factor in determining your cap rate, it's important to understand and calculate this metric accurately. By doing so, you can make more informed investment decisions and increase your chances of success in the real estate market.

What does it mean if your NOI is negative?

A negative NOI means that a property costs more to maintain than it generates in income. This can be a major red flag for investors, as it indicates that the investment may not be profitable in the long run.

If you're considering investing in a property with a historically negative NOI, it's wise to do your due diligence and investigate why this is the case. There may be a good reason for the negative cash flow —such as a low purchase price or high-quality tenants — but landlords should know the risks associated with such an investment.

How can you increase your NOI?

As a real estate investor, there are a few things you can do to increase your NOI. First is to increase your income, which generally requires increasing your rent prices or finding new tenants. However, you don't want to charge too much, or you may risk losing tenants or dealing with long vacancies. Striking a balance between price and demand is key.

Another way to increase your NOI is to keep your expenses as low as possible. This means carefully tracking your spending to make sure that you're not paying too much on renovations, maintenance, property managers, and other costs.

Your mortgage is usually the biggest expense for rental properties. Azibo can streamline your next rental purchase by finding the most competitive loan rates tailored to your specific needs.

Why landlords should track Net Operating Income

It's important for rental property buyers to be aware of a property's NOI before making an investment decision. By doing so, you can avoid costly mistakes, keep expenses reasonably low, and ensure that your investments are as profitable as possible. Landlords who want to increase their chances of success in the real estate market should take the time to understand net operating income.