Net Operating Income

At GoodLife Housing Partners, we are always looking for ways we can increase our Net Operating Income (NOI). In Episode 73 of Investing with GoodLife, Rohan and David further discuss why NOI is an important metric that we are constantly using in our deal analysis. By the end of this article, we hope you know the following about NOI:

• Understand how to calculate NOI
• Ways to increase NOI
• GLHP’s Point of View on NOI

What is NOI?
NOI is a calculation used to analyze the profitability of income-generating real estate investments and is the standard metric used in the commercial real estate industry today. To define NOI simply, it is the net operating income or revenue generated from an investment (for example, rents plus other ancillary income), minus the top-line expenses (eg..general expenses incurred in operating the real estate asset such as taxes and insurance). NOI is ultimately a snapshot of the economic viability of a real estate investment. Even though NOI is not the final end-all-be-all of metrics in analyzing a real estate investment, it is a critical measure to consider because if you can increase the NOI of a real estate asset, you are able to increase the overall value of the property. This is because most investors today value and price real estate assets based on the property’s NOI.

NOI is a key component in many other valuable real estate metrics. For example, in Episode 72 (Linked at the bottom of this page), David and Rohan discuss how a Cap Rate is calculated by dividing net operating income by property asset value or purchase/sale price.

What isn’t included in NOI?
One important thing to keep in mind though is that NOI does not include *below-the-line expenses, the biggest ones being mortgage interest and other loan payments. As Rohan describes in the podcast, interest, and loans aren’t calculated in NOI because these factors are different for every borrower.

“The way I generally look at it is, the interest rate on a loan that Warren Buffet could get, versus the loan the average guy on the street could get, is going to be a little bit different.”

– Rohan Gupta

Even though NOI doesn’t take into account these expenses, as well as other costs incurred in the ownership of real estate, such as capital expenditures, it’s a much more precise calculation compared to simpler metrics such as GRM because it takes into account all revenue streams, while also accounting for most operating expenses.

How GLHP Believes NOI is Evolving
One thing changing, as the industry shifts, is insurance costs. While insurance costs used to be fairly fixed, today, insurance premium costs are on the rise all across the United States. For example, in Texas after multiple storms, tornados, etc. insurance prices have risen considerably in the last few years.

Because of this, owner-operators like Rohan and David, are always trying to find creative ways to reduce insurance costs. An example of how they are accomplishing this is pooling the insurance policies of separate properties together by using the same property management company’s master insurance program. This has led to savings of over 20% in many cases.

*below-the-line expenses: below the line refers to line items in the income statement that do not directly impact a firm’s reported profits and thus, the calculation of the NOI. For example, a firm may classify certain expenditures as being capital expenditures, thereby pushing them below the line by shifting them from the income statement to the balance sheet.