How to Calculate Net Operating Income (NOI)

To calculate Net Operating Income, you add up all of the annual income, often referred to as Gross Adjusted Income, and subtract all of the Annual Operating Expenses.

So:  Gross Adjusted Income minus Annual Operating Expenses equals Net Operating Income

Gross Scheduled Income vs Gross Adjusted Income:  Gross Scheduled Income is the sum of all anticipated income to be received from rents and from other sources (late fees, laundry machines, vending machines,storage areas, advertising, etc…).  While Gross Adjusted Income is the Gross Scheduled Income, LESS your vacancy factor.

Vacancy Rates are expressed as a percentage.  This is the percentage of the scheduled rent not collected due to vacancies in the building or rent not collected.  The Gross Scheduled Income needs to be multiplied by this percentage to produce the amount of lost income due to the vacancy factor.  This amount is then subtracted from the Gross Scheduled Income.

For example:  $120,000.00 Gross Scheduled Income x .07 (7% Vacancy Rate) = $8,400.00

So $120,000.00 less $8,400.00 = $111,600.00

Therefore, $111,600 is the amount that should come in from rents during the year, after having accounted for vacancies.

How do you determine Vacancy Rate?  There are basically two ways:  The first way is by analyzing the project’s previous income statements and averaging out those numbers.  The second way (and safest way if you plan on obtaining a loan to purchase the unit) is by asking your lender.  Most local, commercial lenders already have this information, and they use it when approving (or disapproving) you for a loan.

BUYER BEWARE

Often in the marketplace, you will find people trying to base their income and expense calculations on projected rents.  This can occur when rents are below market or there are higher than normal vacancies.  Either way, making calculations based on projected rents is an attempt to make the property look better economically.  But using projected rents can be problematic.

Rents could be below market because the sellers have not raised the rents for fear of losing tenants, or possibly they are at the end of a long lease term lease that is below-market rent.  In the first case they are trying to suggest that the new buyer should assume the risk of raising rents.  In the latter case, the lease term will need to expire and the tenant will need to be renewed or replaced.  Either way, there are risks the buyer assumes, primarily related to the fact that if the rents are too low and are raised there is usually a degree of tenant turn-over that must be accounted for.  This means that there will be vacancies.

When there are higher than expected vacancy rates and the seller is suggesting that the new owners can lease up the property to achieve a certain return, the buyer should always take into account the expenses needed to achieve the projected rents.  For instance, if there are vacancies that need to be filled, there are also expenses that will be incurred, such as possible improvements, advertising for the spaces, and commissions to brokers who help fill those spaces.

Another reason why projected rents are problematic is lenders won’t usually lend based on the projected numbers (the common exception being in the case of new construction).  They want to see actual numbers and you should as well.  So when calculating cap rates and other numbers, always get the actual numbers, not the projected ones.

Annual Operating Expenses are those usual and recurring expenses related to the successful maintenance and operation of the property.  They don’t include debt service (money to pay the mortgage) or income taxes.

Some examples of operating expenses may include:

  • Real Estate Taxes
  • Personal Property Taxes
  • Property Insurance
  • Leasing Fees
  • Management Fees
  • Advertising
  • Utilities
  • Maintenance & Supplies
  • Payroll Taxes & Worker’s Comp
  • Security
  • Janitorial & Trash Removal
  • Landscaping & Parking Lot Maintenance
  • Professional Fees (Accounting & Attorney)

So to recap:   Gross Adjusted Income minus Annual Operating Expenses equals Net Operating Income

Gross Adjusted Income & Gross Scheduled Income

To determine the Gross Adjusted Income, you must start by determining the Gross Scheduled Income.  To arrive at the Gross Scheduled Income, add up all of the rents for the year.

The Gross Scheduled Income is simply the amount of income scheduled to come in from rents over the next year.  You start with the Gross Monthly Rental Income.  This means that you take all of the current rents (often referred to as your Rent Roll) and add them up.  You then need to multiply by 12 in order to get the total amount of rent for the year.  This annualized number is often called the Gross Scheduled Income.  Meaning that this is how much income is scheduled to come in if there are no vacancies and every tenant pays the full amount of rent being charged for the space, each and every month.

For example:

If the property has 10 units that each rent for $1,000 per month, the Gross Scheduled Income would be $120,000.
10 units x $1,000 = $10,000
12 months x $10,000 = $120,000

Then subtract the annual vacancy factor from the Gross Scheduled Income.

The Gross Scheduled Income needs to be multiplied by the vacancy rate to produce the amount of lost income due to the vacancy factor.  This amount is then subtracted from the Gross Scheduled Income.

For example:
$120,000 Gross Scheduled Income x .07 (7% vacancy factor) = $8,400
$120,000 – $8,400 = $111,600

In the above example, $111,600 is the amount that will come in from rents during the year, after having accounted for vacancies.  If this number is calculated based on the vacancy rate provided by your lender, it may not be completely accurate, but it will satisfy the lender’s requirements for funding.  The accurate number may be higher if in fact the actual vacancy rate is lower than what the lender requires for the property type.

Once you have calculated the income from rents, you need to add in any other income from other sources.  Properties often have significant income from sources other than the leasing of the units.  In a multi-family complex, it  might include:

  • laundry income
  • garage or storage unit rentals
  • vending machines
  • game room revenues
  • advertising revenues
  • revenues from any distribution of outside services like cable, satellite or internet

The result is known as the Gross Adjusted Income.

Gross Scheduled Income (GSI) – (GSI x Vacancy Rate) + Other Income = Gross Adjusted Income