A.CRE

Net Operating Income

The net income from a property, in a given period, after deducting operating expenses but before deducting capital expenditures, debt service, and taxes. To calculate Net Operating Income, the real estate professional subtracts operating expenses from effective gross income (Effective Gross Income – Operating Expenses = Net Operating Income). Net Operating Income is arguably the most important income metric, as it is widely used to estimate the value of the property using the Income Capitalization Method.

Putting ‘Net Operating Income’ in Context

Prairie Point Capital, a real estate private equity firm specializing in core acquisition investments, is evaluating the purchase of North Haven Marketplace, a grocery-anchored retail center in suburban Minneapolis, Minnesota. This 95,000 square-foot property, built in 2015, is anchored by a major national grocery chain that occupies 55 percent of the space, with the remaining space leased to a mix of retail tenants, including a pharmacy, a café, and a fitness studio. The center boasts strong occupancy at 95 percent and is located in a high-traffic area, making it an attractive investment.

Calculating Net Operating Income

To determine the potential value of North Haven Marketplace, the firm focuses on its Net Operating Income (NOI), a key metric that drives property valuation using the income capitalization approach.

Key Financial Information:

  • Effective Gross Income (EGI): $1,800,000 per year
  • Operating Expenses: $540,000 per year

Using the formula:

  • Net Operating Income = Effective Gross Income – Operating Expenses

Calculation:

  • NOI = 1,800,000 – 540,000 = 1,260,000

Application of NOI

Prairie Point Capital uses the calculated NOI to estimate the property’s market value using the Income Capitalization Method, assuming a market capitalization rate of 6.5 percent for similar grocery-anchored retail centers in the area.

  • Property Value = NOI / Cap Rate = 1,260,000 / 0.065 = 19,384,615

Based on this valuation, the firm determines that acquiring North Haven Marketplace at or below $19.4 million would align with its target return metrics for core investments.

Conclusion

The calculation of Net Operating Income highlights the profitability of the property before financing and capital costs. By focusing on NOI, Prairie Point Capital can assess the intrinsic earning potential of North Haven Marketplace and make an informed investment decision.

Frequently Asked Questions about Net Operating Income (NOI)

Net Operating Income is “the net income from a property, in a given period, after deducting operating expenses but before deducting capital expenditures, debt service, and taxes.”

NOI = Effective Gross Income – Operating Expenses.
In the North Haven Marketplace example, EGI is $1,800,000 and operating expenses are $540,000, resulting in an NOI of $1,260,000.

NOI is “widely used to estimate the value of the property using the Income Capitalization Method.” For North Haven Marketplace, NOI of $1,260,000 divided by a 6.5% cap rate yields a property value of $19,384,615.

Capital expenditures, debt service, and taxes are not included in NOI. NOI focuses only on the income and day-to-day operating expenses of the property.

NOI allows investors to assess a property’s “intrinsic earning potential.” In Prairie Point Capital’s case, they used NOI to ensure the investment in North Haven Marketplace aligned with return targets.

NOI measures income before capital expenses, loan payments, and taxes. Cash flow accounts for those costs, so it reflects what the owner actually keeps, while NOI reflects operational profitability.

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