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What is NOI (Net Operating Income) in Real Estate?

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Real estate investors are always looking for ways to increase their returns from multifamily investments. In order to do this successfully, however, there are many things you need to understand about real estate investing and the real estate market. Investors need to have a good understanding of certain financial concepts, including Net Operating Income or NOI.

For real estate investors, Net Operating Income is an essential calculation. You have to know how to calculate it if you want to make better investment decisions. Understanding NOI will help you make financial decisions quickly and narrow down your options much faster.

Here we will talk about NOI calculation and how you can increase your real estate investment property’s NOI.

What You Need to Learn About NOI in Real Estate

Net Operating Income measures the profitability of an income-producing property before adding in any costs from taxes or financing. It is a mathematical formula that is used to evaluate potential investment properties to see how profitable it is in a single year. [1]

This formula is used by real estate experts and investors to quickly assess an investment property’s profitability and revenue after subtracting the necessary operating expenses. NOI considers all the income generated by a property, minus all general expenses. [1]

NOI does not calculate income vs. expenses on an investor level, but rather at a property level. Total operating expenses may vary from one person to another, so keep this in mind when looking into different properties.

Calculating net operating income is simple: you have to subtract operating expenses from all the revenue that is generated by the property.  This simple calculation should give you an idea of whether or not a property is worth owning and maintaining. [2]

Aside from rental income, a property may generate income from certain amenities like laundry facilities, parking areas, and even vending machines. Meanwhile, operating expenses include the costs of running and maintaining the building, plus other expenses like legal fees, repair costs, property taxes, janitorial fees, insurance premiums, and utilities. [2]

Real estate professionals use NOI to determine the value of their income-producing properties.

NOI is also used in the debt coverage ratio (DCR) for financed properties. It can also be used to calculate the net income multiplier, total return on investment, and cash return on investment.

It is important to note that NOI is just one method to quickly assess properties so that investors can make better purchasing decisions. You still need to do your due diligence to get a clearer picture on any investment property.

How Do You Calculate Net Operating Income in Real Estate?

The formula for Net Operating Income is as follows:

Net Operating Income = (Gross Operating Income + Other Income) – Operating Expenses.

Although the Net Operating Income formula is simple, you need to make sure you include all the right numbers in your calculation to get the proper result.

To calculate your NOI correctly, you need to calculate your Gross Operating Income (GOI) first, and this follows the formula of: Gross Operating Income = Potential Rental Income – Vacancy Rates.

As demonstrated here, the gross income is not just the property’s value. That is a common misconception. GOI accounts for fluctuations and possibilities in the property’s income. [1]

Your potential rental income or PRI refers to how much the property would make if it was 100% leased, 100% of the time. Unfortunately, it is not entirely realistic to expect the property to be 100% leased for an entire year, so you also have to account for vacancy and credit losses. You have to subtract the vacancy and credit losses from your PRI to get an accurate GOI. [1]

Since NOI also takes into account other income generated, you have to determine how much money a property makes outside of tenant rents. This will depend on the number of amenities you have that can generate revenue. With that in mind, not all real estate investment properties make additional income.

Once you have added your GOI with your other income, you can now subtract your operating expenses. However, operating expenses are not just your maintenance fees. You also need to include insurance and professional help.

Here are the operating expenses that you need to include in your calculations: property taxes, insurance, property management fees, maintenance costs, repair costs, accounting and attorney fees, and marketing costs. NOI is usually calculated on an annual basis.

Does NOI Mean Profit?

NOI refers to the profitability of real estate investment properties. As a before-tax figure,  it appears on a property’s income and cash flow statement. This includes principal and interest payments on loans, capital expenditures, amortization, and depreciation. [2]

For multifamily investors, NOI is especially important because it helps them compare potential investment opportunities. Investors use capitalization rate or cap rate as one of the primary ways to evaluate properties, and NOI is part of the cap rate calculation formula. Basically, the higher the NOI, the higher the property value in terms of cap rate. [3]

What is a Good NOI in Real Estate?

Some investors ask: what is a good Net Operating Income percentage? NOI is actually not a percentage, but a number that is calculated based on revenues and expenses of a real estate property.

NOI may vary greatly from one real estate property to another so there is no specific value that we can say is the ideal NOI. But generally speaking, the higher this number is, the better.

Is Mortgage Included in NOI?

As a rule, Net Operating Income does not include numbers that can be written off against taxes and future earnings. Major repairs and other one-time costs are also excluded in the calculation. These numbers are excluded simply because they do not serve the purpose of NOI.

The purpose of calculating a property’s NOI is to give investors an idea on its true cash flow. It shows investors whether or not a property is profitable and worth investing in. NOI shows them the overall health of a property, which allows them to make informed investment decisions.

Determining true cash flow of a rental property is the main goal of NOI, so we can exclude certain numbers from the calculation, and that includes mortgage payments and other debts. The amount of debt can vary from one investor to another, so there is no need to add it to the NOI calculation. For example, one investor may be able to put 40% down, while another can only put 10%. If this number was included in the calculation, it would significantly affect the NOI. The financials of a specific investor are not necessary to determine the overall health of a real estate property. [1]

NOI calculation excludes debt so that properties may be compared on the same merit. If you want to measure a property’s cash flow to determine how much it needs to cover loans, you should calculate its Debt Service Coverage Ratio or DSCR. DSCR takes NOI into consideration. [1]

When determining a property’s NOI, you should also exclude income taxes since this is a pre-tax calculation.

Other numbers you will have to exclude are depreciation, tenant improvements, and capital expenditures.

Depreciation is not considered an actual expense. Investors never pay for depreciation out of pocket. Instead, this is more of an accounting concept. It is only during the sale of a potential property that depreciation becomes “real money”. It’s either that or when you are writing it off on your taxes. [1]

Tenant improvements are excluded because they are specific to the tenant instead of the property as a whole.

Finally, capital expenditures are excluded because this expense can vary widely from property to property, and year to year. Therefore, no matter how much capital you need for the maintenance of your real estate property, you do not have to include it in an NOI calculation. [1]

How Do You Increase Your NOI?

For real estate investors who want to increase the NOI of their investment property, there are plenty of ways to do so. The first and most obvious method is to increase the rent for each unit. You may try this upon unit turnover or lease renewal.

Most landlords base their rent increases on inflation, making sure they are at least keeping pace with it. [3]

Landlords should update their lease agreements to mention that lease renewal rates may change depending on increases in the Consumer Price Index (CPI), which is affected by inflation. The costs of owning and maintaining a multifamily real estate property in an inflationary environment tend to increase. In order to increase NOI, landlords need to account for these increased costs as they adjust their rent.

Aside from increasing rent, you may also consider increasing the fees that are charged to the tenants such as credit reporting fees, late fees, pet fees, etc.

Another potential source of income for landlords is utility income. Consider individually metering each unit. Doing so will allow you to shift the cost of utilities onto renters. Utility income can be a tremendous source of income for you, which would translate well into your NOI. However, if you take this approach, you may have to lower the base rent since renters are going to pay for their own bills. [3]

Adjusting rent and making changes to your utilities are some of the most effective ways to increase your NOI. But you can also add additional income streams by introducing services and amenities.

An on-site storage is a good example of this. If the real estate property has some underutilized space, the landlord can add storage closets with locks, which tenants can rent out. Whether it’s a basement or a brand new structure outside of the main apartment building, this could be a good source of additional income. It can be an extension of your business. In any case, it will increase your NOI.

If you don’t want to go this route, you can try adding a laundry room. Most landlords provide free in-unit laundry facilities. But adding a coin-operated laundry in a common area allows you to generate some extra income on a regular basis.

For real estate properties that already offer in-unit laundry, landlords should consider charging a premium for those units.

Collecting parking fees is another good way to increase NOI, especially in dense urban areas with limited parking. You may charge a premium for that parking space, especially if it is covered or underground. In a large apartment complex with plenty of tenants, this could be a strong source of income, especially if some tenants have multiple vehicles. [3]

Why Smart Real Estate Investors Choose Apartment Complex Investing

NOI matters to real estate investors because it helps them make investment decisions. Once they own a property, they can make adjustments to increase the NOI of their investments.

But why do smart real estate investors go for apartment complexes? Apartment complexes are multifamily real estate properties, meaning they have multiple units that can be rented out. This comes with a number of benefits, which we will discuss below.

Thanks to the impressive number of units in an apartment building, investors can expect a strong and stable cash flow. You can rely on its consistency because tenants will provide monthly rent. [4]

Tenants usually stick around for years, which means you do not have to worry as much about vacancies. Even if one or two units become vacant every now and then, your cash flow will remain stable because you still earn rental income from the occupied units. If your multifamily investment property is in a good location and offers high quality amenities, you can expect these vacancies to be filled up almost immediately.

The best part is that you do not even have to collect rent yourself. Property management is a huge concern for a lot of investors who don’t want to take on the responsibilities of a landlord. That is perfectly understandable. Not many people want to go through the challenges of running a large multifamily property: collecting rent, managing repairs, handling emergencies, and dealing with tenants.

Multifamily properties are profitable enough that you can afford to hire a third party property management company to handle this part of the job for you.

Multifamily real estate properties also enjoy valuable tax benefits. Property owners and investors alike benefit from the current US tax laws. As an investor in multifamily real estate, you will find many different ways to lessen your tax payments. With lower tax obligations, you can enjoy greater profits. Work with a knowledgeable professional to learn more about your tax benefits as a multifamily real estate owner or investor. [4]

As a multifamily real estate investor, you may also discover that investing in these large apartment buildings allows you to create forced appreciation. In a single-family home, appreciation occurs when the market price of other homes in the neighborhood increases. But for apartment complexes, the value is determined by the rental income generated. [4]

You don’t have to wait for the neighborhood to keep up with you. You can just introduce new services and amenities to increase your rental fees and force appreciation.

Finally, investing in multifamily real estate is a great way to build a large portfolio of lucrative real estate properties. With this type of real estate investing, you can build your portfolio within a relatively short period of time. Just imagine being able to invest in a 50-unit apartment building instead of investing in 50 different single-family properties. The latter is much more time-consuming.

Why the SMARTEST Investors Work with BAM Capital for Multifamily Syndication

Because of all the reasons mentioned above, multifamily real estate investing is already a smart move for a lot of investors. But for accredited investors with the net worth and the annual income to qualify for exclusive investment opportunities, there is an even smarter option that is worth exploring. This is multifamily real estate syndication.

A lot of investors do not want to try multifamily real estate investing no matter how lucrative it may be, simply because they know it can be difficult to manage. Not everyone is interested in becoming a landlord. If you don’t have the experience, it could be tricky running something as big as an apartment building with hundreds of tenants.

You could hire a property management company and have them run it for you, but this still takes a lot of work.

With a multifamily syndication deal, you do not have to worry about any of this at all, because it is a passive investment. In a syndication deal, a syndicator acts as the General Partner and locates the real estate property. They put the deal together, they handle the financing, and then they look for investors who will participate and provide most of the capital needed to acquire the property.

A syndication deal therefore involves multiple investors pooling their resources together to obtain a single real estate property. Multifamily real estate syndication is the most popular type of syndication deal due to the benefits we listed above.

Aside from the natural benefits of an apartment complex, you also get to enjoy the fact that the syndicator handles property management. Either they will handle the property themselves or hire a third party company. You don’t have to do anything other than provide a portion of the capital. You can then sit back, relax, and focus on other important tasks.

Multifamily real estate properties are usually difficult to acquire for lone investors. They are expensive and require a large capital investment. Even for wealthy individuals, this is not usually a good idea. But multifamily syndication allows high net worth individuals (HNWIs) to participate in multifamily real estate investing without actually going through all the work.

Real estate syndication solves two of the biggest concerns among real estate investors: the high barrier to entry and the property management.

The only thing you should take note of is the fact that your capital will be locked up for a long time if you join a multifamily syndication deal. Deals like this typically last for years, which means your funds will be inaccessible for that period.

Syndication deals are often exclusive for accredited investors—people with enough financial sophistication to assess the risks of certain unregistered securities. Accredited investors also have the financial safety net that other investors do not have, thanks to their high net worth and income. Accredited investors tend to be more comfortable with a bit of illiquidity.

When it comes to multifamily real estate syndication, BAM Capital is the best company to work with. BAM Capital helps accredited investors participate in apartment complex real estate investing without the headache of becoming a landlord of managing tenants.

BAM Capital is an Indianapolis-based syndicator that has a strong Midwest focus. It offers high quality multifamily real estate properties that are Class A, A-, and B++. With its vertical integration, BAM Capital is an expert in the field of real estate investing. It uses an award-winning investment strategy that helps accredited investors grow their wealth through real estate syndication. [5]

Known for its consistent track record, BAM Capital mitigates investor risk and creates forced appreciation to boost their ROI. In fact, BAM Capital currently has $700 + million AUM and 5,000 +  units. [5]

For those who want a safe and passive investment in multifamily real estate, trust BAM Capital. They will negotiate the purchasing and financing of high quality multifamily properties on your behalf.

No investment is without risk. Make sure to consult your investment advisor or speak to a BAM Capital investment team member before making any financial decisions.

Accredited investors can schedule a call with BAM Capital and invest today.

 

 

BAM Multifamily Growth & Income Fund III

BAM Capital created this fund in order to yield consistent and reliable cash flow, long-term appreciation, and accelerated tax benefits. The fund aligns with BAM Capital’s demonstrated track record of successful multifamily investing by continuing to implement our signature investment thesis, now in fund format. The fund aims for greater overall returns and lower risk through a multi-asset diversification strategy.

  • Consistent passive income
    Lower-risk assets with in-place cash flows with the ability to distribute preferred return after acquisition.
  • Significant tax benefits
    A cost segregation analysis allows for accelerated deprecation to years of ownership. This large passive loss gets passed onto investors through a K1.
  • Vertically integrated company
    In-house property management and construction allow for predictable cost reduction and value add.

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The contents on this site are for informational and entertainment purposes only and do not constitute financial, investment, or legal advice. BAM Capital cannot guarantee that the information shared on this post or page is appropriate for you and your financial situation. By using this site, you agree to hold BAM Capital and any and all entities related to the writing & publishing including BAM Capital’s parent company harmless from any ramifications, financial or otherwise, that occur to you as a result of acting on information found on this site. Always consult your investment advisor, CPA, and other professionals before making an investment. BAM Capital is excited to help you grow your investment assets. Please contact us to see how we can help you.  

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