Understanding Net Operating Income (NOI)

Understanding Net Operating Income (NOI)

Net Operating Income is one of the most important components of financial analysis for commercial real estate investors. A few months ago we discussed another important financial index, CAP Rates, which are determined directly from the NOI.

What is the NOI?

The NOI is calculated as follows:

NOI = GOI – Expenses, where GOI is the Gross Operating Income of the commercial real estate asset. Expenses include property taxes, insurance, maintenance, utilities, capital reserves, management fees and incidental expenses. NOI is analogous to a simple profit calculation for a business.

Of course, the commercial property’s Gross Operating Income (GOI) is needed for the NOI calculation. The GOI is determined by subtracting the vacancy rate reserve from the Scheduled Gross Income (SGI). This is done to adjust the SGI for tenant vacancies. The SGI is simply the total amount of rents scheduled to be collected annually.

An investor (buyer) typically obtains the necessary financial information by requesting it from the seller or the seller’s agent prior to executing a commercial real estate sale transaction.

It is customary that the sale transaction purchase contract sets forth the details by which the buyer and his agent verifies or determines a NOI and other important components of his financial analysis by his own due diligence work, while in escrow.