'Net Operating Income' is explained in detail and with examples in the Accounting edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.
Net Operating Income can refer to two different concepts. It may be used in regards to companies and corporations, or to properties and their annual incomes. Where companies are concerned, Net Operating Income, also known by its acronym NOI, is the income after deducting the company’s operating expenses. It is figured up in advance of taking off interest and income tax deductions.
When this number proves to be a positive number, it is called net operating income. If the number turns out to be a negative value, then it is referred to as a Net Operating Loss, also known by the acronym of NOL. Many analysts like to look at the Net Operating Income as a realistic picture of how a company is performing. They feel that this number is more difficult for management to manipulate than are other numbers in the income statements of a company.
Pertaining to properties, Net Operating Income equals the annual gross income minus the expenses for operating. In this respect, the gross income is comprised of real income from rentals as well as other incomes like laundry receipts, vending receipts, parking charges, and every type of income that is related to properties. Operating expenses prove to be the expenses that are encountered in the typical maintenance and operating of the property in question. Among these expenses are insurance, maintenance, repairs, utilities, management fees, property taxes, and supplies. Some costs are not deemed to be operating expenses, such as capital expenditures, interest and principal payments, income taxes, depreciation, or amortization of the points on a loan. So, calculating the Net Operating Income on a property involves first taking the various forms of annual gross income and adding them all up. Then the operating expenses should be taken and added up. Finally, the operating expense total is subtracted from the operating income total to achieve the Net Operating Income figure.
In real estate, Net Operating Income is utilized within two critical real estate ratios. The Capitalization Rate, also know as the Cap Rate, is employed to come up with an estimate of the actual value of properties that produce income. For example, maybe a property being considered for purchase possesses a market capitalization value of ten. Coming up with the market cap rate is achieved by considering the financial information from the sales of properties that produce income and are similar in a particular market.
The other important real estate ratio that relies on Net Operating Income is the Debt Coverage Ratio, also know as the DCR. The Net Operating Income proves to be a critical component of this DCR ratio. Investors and lenders alike utilize the debt coverage ratio to determine if a property has the capability of covering both its mortgage payments and operating expenses together. A result of one is deemed to be the break even point. The majority of lenders want at least a 1.1 to 1.3 ratio in order to contemplate making a commercial loan to a given property. The higher this debt coverage ratio works out to be in a banks’ opinion, the safer the loan will ultimately be.