Running a successful commercial real estate business means becoming familiar with key metrics and performance indicators. These metrics help you easily understand the performance of your properties or your portfolio as a whole, helping you quickly spot financial problems and communicate successes with investors.
One of the most important performance indicators is net operating income (NOI). Here, we’ll dig into how NOI works, what it’s used for, and how to improve it.
What is Net Operating Income?
Net operating income represents a property’s revenue minus its operating expenses. This is a basic way to measure how profitable a property is. Due to differences in size, occupancy, and operating requirements, there is no single number that makes a “good” NOI, but a higher number is always better. A negative NOI indicates that a property is actually losing money and is likely not a good investment.
Why is Net Operating Income Important in Commercial Real Estate?
NOI offers an easy way to see a property’s profitability, meaning that it is extremely important for a variety of people across commercial real estate businesses. Current owners and property managers can use it to identify revenue and expense problems, while potential buyers and investors can use it to understand a property’s potential.
In addition, NOI is necessary in calculating capitalization or cap rates, another key performance metric. You can calculate cap rate by dividing a property’s NOI by its market value. This number helps potential buyers and investors determine how much the property is expected to return.
Formula to Calculate Net Operating Income
Follow this simple formula to calculate net operating income:
Gross Income – Operating Expenses = NOI
A property’s gross income is its total income before accounting for any expenses.
Factors Not Considered in Net Operating Income
It is important to note that net operating income does not account for some common expenses and therefore doesn’t tell the whole financial story. Because of this, it is always a smart idea to pair NOI with other performance indicators and reports to get a full picture of a property’s performance. In order to calculate it correctly, remember that NOI does not include these costs:
Income Taxes
Income taxes apply to the owner or investor individually and depend on additional factors outside of a specific property. Because of this, they are excluded from NOI calculations.
Debt Service Costs
Like income taxes, debt service costs are individual and do not count in NOI calculations.
Tenant Improvements
Tenant improvements are changes that individual tenants make within their space to suit their particular business needs. These costs are considered outside of NOI.
Capital Expenditures
Capital expenditures, costs associated with major, infrequent repairs, also do not count towards NOI. Because these repairs occur irregularly and because property owners often save and plan for them well in advance, their high costs can distort the true picture of a property’s performance.
How to Improve Net Operating Income
Again, there is no single target number to hit with NOI, as costs and revenue will differ between different types of property. However, raising NOI can make your property much more attractive to potential buyers and investors. Try out these strategies to raise your property’s net operating income.
Use Preventative Maintenance
Preventative maintenance helps lower costs of unexpected repairs down the road. Large, sudden costs can make your NOI drop. Set up a plan now for regular service on each property.
Leverage Automations
Automating your property management and accounting systems can help you avoid calculation errors, missed payments, and other simple mistakes that are easy to miss when doing work by hand. Even small errors can add up to large amounts of missed revenue over time, harming your NOI.
Improve Communications with Tenants
Good relationships and communications with your tenants can help raise your NOI in a variety of ways. Better tenant communication helps you resolve issues and perform needed improvements efficiently. This results in more satisfied tenants who are more likely to renew their leases, improving your NOI. Additionally, when it is easy for tenants to communicate with you and receive frequent reminders about rent payments, they are more likely to pay on time, which will also increase revenue.
How STRATAFOLIO Can Help
STRATAFOLIO property management software is a tool designed specifically for commercial real estate tasks, including helping you calculate net operating income and finding strategies to improve it. Take advantage of a complete two-way integration with QuickBooks Desktop and Online to access up-to-date financial information at any time.
STRATAFOLIO quickly generates a variety of reports that help you analyze financial performance of individual properties or your portfolio as a whole, helping you catch issues that could endanger your NOI. Plus, a built-in tenant portal allows for easy communications and online rent payment to avoid missed revenue.
For more details on how STRATAFOLIO can help you manage your NOI and general business performance, schedule a free 1:1 demo today.
