Net Operating Income (NOI) & How To Calculate It

Real estate investors need information. The more information they have, the better the decisions they can make. There are a lot of tools to provide this information, but one of the most important is net operating income (NOI). Understanding what this calculation is and how to use it can help investors make decisions quickly regarding any property an investor is considering.

What Is Net Operating Income?

The NOI formula allows a real estate investor to determine how profitable a property could be. The formula is straightforward. Subtract all of the operating expenses for the property from the expected revenue it should generate. Expected income may include rental income but also any additional fees or income associated with the use of the space. Operating expenses may include any type of general expenses for the property, such as insurance costs, taxes, and repairs.

With this information, an investor can see if the cost of operating the property is more than the potential earnings from it, making it easy to determine if that investment is appropriate for their goals and financial needs. Often conducted prior to purchase, it may help in making buying decisions between multiple properties. For example, if there is a consideration for purchasing a convenience mart, this calculation would take into consideration all potential avenues of income from that convenience mart. That may include tenant rent as well as any income from the sale of goods. It would also consider all maintenance fees for the property and any other associated costs, such as the attorney the investor uses or the insurance on the property. This is what makes net operating income so valuable. It takes into consideration all of the income and expenditure opportunities for the property in one single calculation. As a result, the investor knows right away if this is the type of investment that fits the investor’s portfolio or not. NOI is calculated before tax. It is often presented on a property’s income and cash flow statement. Typically, it does not include principal and interest payments on loans, depreciation, capital expenditures, or amortization.

Why Is Net Operating Income Important?

The key to using NOI is to understand its value. When an investor uses this calculation, it will help provide insight as to the property owner if renting out the property is worth the expense of purchasing it as well as maintaining it over time.

Often, this information can help prospective investors determine which property available to them may offer the highest return or fit within their property investment strategy best. It allows the investor to compare several properties with the same metrics, making it easier to see the difference in each.

How to Calculate Net Operating Income

To calculate this information, it is necessary to have all data available (as much as possible). The simplest explanation is to subtract all of the operating expenses required for the property from the revenue the property could generate. Revenue may include:

• Rental income
• Service charges
• Vending machines
• Parking fees
• Other sources

The operating expenses could include:

• Property management fees
• Insurance costs
• Maintenance and upkeep costs
• Utility costs
• Property taxes
• Repairs

Net operating income formula:

Net operating income = RR – OE

RR: Real estate revenue OE: Operating expenses

Example of How NOI Works: Net Operating Income Formula Example

The NOI can be applied to many types of commercial real estate. In every situation, though, the prospective investor needs to consider all avenues for generating an income for that space.

Consider the use of a townhome. A prospective investor wants to learn how much of a potential profit they could generate from the rental of the townhome. The property features 4 townhomes under the same roof and would be leased to resident tenants. Here is a basic overview of what could occur.

Calculate the revenue

The first step is to add up all the revenue that comes from owning this townhome and renting it out on a yearly basis.

• The total rent collected ($1000 per month per unit equals $4000 per month, for a gross $48,000 in rental income for the 4 properties)
• Garage rental costs ($50 per month per unit, equaling $200 per month, or $2400 per year)
• Laundry machine use ($25 per month, per unit, equaling $100 per month, or $1200 per year.)

In this situation, the total income from the property could be $51,600.

Calculate the expenses

The next step is to determine the total cost of operating the townhome property. Some of the costs could include:

• Property management fees: $5000 a year
• Property taxes: $10,000 a year
• Maintenance on the property: $10,000 a year
• Expected repair costs: $15,000 a year
• Insurance: $8,000 per year

In this situation, the total operating expenses for the property are $34,500. To determine NOI, use the formula for NOI: $51,600 minus $34,500 equaling: $17,100 That means that the property would yield $17,100 in profit each year, assuming these figures hold up.

Evaluating the Potential of a Property

Not every situation produces a positive result. Suppose a property’s NOI shows a negative result. In that case, that could indicate the property would not be profitable to manage, especially if the costs cannot be lowered in any other way. Some potential investors may think of the long-term outlook after they’ve made repairs or updated the property to lease it at a higher rate. However, if that does not happen, the NOI may not be positive.

Borrowing to Buy Commercial Real Estate Relies on NOI Information

While NOI is a very important determinant of the value of any property for investors, it is also an essential factor for lenders. Most creditors and commercial lenders will rely on this information to determine the potential income generation for the property. Suppose the investors hope to secure a loan on the property. In that case, the lender needs to ensure that the income generation potential here meets the financial obligation the borrower is taking on.

It allows commercial lenders to assess the initial value of that property by getting a better idea – or for casting – cash flows for it. If the property presents a positive, profitable NOI, that indicates to the lenders there may be some stability in this loan, and they may be willing to make it. If the property shows a negative NOI, that may mean the lender will reject the loan request because of the high risk for the property. In some situations, property buyers may manipulate this information. For example, they may be able to defer some types of expenses while accelerating costs. This may include altering the rents and other fees they plan to charge to present a more positive outlook for the lender. However, it is critical to consider the accuracy here since this could play a role in just how profitable any investment could be over the long term. What is a good NOI? That depends on the specific situation. NOI is not a percentage but rather a dollar amount. Investors need to take into consideration what level is appropriate for their unique needs. The higher the NOI is, the more profit potential it has. The use of NOI is very important in nearly all commercial real estate investments. It does not take long to calculate once all of the information on operating expenses and potential income is available. It is essential for investors to be as accurate as possible.

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Source: Net Operating Income (NOI) & How To Calculate It

https://www.creconsult.net/market-trends/net-operating-income-noi-how-to-calculate-it/

Apartment Vacancy Has Ticked Up for Seven Consecutive Months

 

Vacancy rates won’t hit 6 percent until well into next year.

Vacancy levels bottomed in October 2021, and since then, the situation has eased gradually but the market remains historically tight.

Apartment List’s data show vacancy ticked up for seven consecutive months, reaching 5 percent in May. Its rent growth index shows a corresponding trend, as price growth has decelerated this year compared to 2021.

The rental listing site said it’s possible that the easing of vacancies could level off in the coming months due to rapidly rising rents that may incentivize many renters to stay put and renew existing leases rather than look for new ones.

“At the same time, the recent spike in mortgage rates has created yet another barrier to a historically difficult for-sale market, potentially sidelining would-be homebuyers and keeping them in the rental market,” the company said in a release.

Demand Leveling in Hottest Apt Markets

Markets that saw large spikes in vacancies in the early pandemic such as San Francisco, Boston, Seattle, and Washington, D.C., have since seen renters return.

Meanwhile, demand is leveling off in the nation’s hottest markets.

Seattle, Boston, and DC (as well as many other similar cities across the country that were greatly impacted by the pandemic) are seeing their rents back above pre-pandemic levels.

San Francisco is a rarity in that it still is experiencing a pandemic “discount,” but even there, rents are up 20 percent since January 2021.

Availability of vacant units nationally remains notably constrained compared to the pre-pandemic norm. “Even if vacancies continue their gradual easing, it won’t surpass 6 percent until well into next year on its current trajectory, the firm estimated.

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Source: Apartment Vacancy Has Ticked Up for Seven Consecutive Months

https://www.creconsult.net/market-trends/apartment-vacancy-has-ticked-up-for-seven-consecutive-months/

Tech Companies Cast Their Eyes on Apartment Portfolios

 

Two recent acquisitions have third-party managers’ and industry analysts’ attention.

When it comes to property management companies and technology supplier partners, the script has flipped for some this year as it’s tech companies that are showing greater interest in acquiring rather than serving these firms.

Looking to build their brand, these innovation firms are — “can gain an instant uptick in revenue growth from the acquisition,” as multifamily tool Lighthouse’s head of business development Sterling Weiss put it, having spoken recently with REITs who have been courted by such companies.

 

For now, technology companies are happy to transact with small- and mid-sized apartment owners and managers.

Twice this year, short-term housing platforms have made this happen. In January, The Guild purchased CREA Management and in March, Alfred purchased RKW Residential. The Brand Guild purchased CREA Management.

 

Both transactions turned the heads among a few in apartment management circles and many are looking to see what could happen next. Some industry observers see more such deals ahead.

It’s a potential win-win because these technology firms believe they can better drive net operating income at the property level.

They are finding the apartment industry is ripe for innovation and that there’s little better way to incorporate, help develop and test their technology through their own housing portfolio.

 

Data Scientists Find Niche in Property Management

Alfred reports that today on average, less than 1 percent of a property’s budget is put toward technology, unlike other innovative industries, which invest closer to 10 percent, based on recent research from Statista, McKinsey, and Deloitte.

For RKW Residential, the technology Alfred brought will make operations more efficient, RKW Residential’s Executive Vice President of Marketing, Joya Pavesi said.

“It’s been a bonus because we now have Alfred’s 40+ software engineers working on our behalf – that’s more engineers than what some of the biggest apartment operators employ,” she said.

The merger gives Alfred the chance to have executive oversight into how its technology is being used by its clients to ensure that its capabilities are being fully realized.

‘Keep A Very Close Eye’ on This Trend

Zain Jaffer, Investor, and Entrepreneur, Zain Ventures Jaffer says that these companies have strong incentives to acquire property management companies to scale their portfolios quickly.

“It’s clear that AI has the potential to completely reshape the nature of property management as we know it,” Jaffer said. “As more and more tech companies buy into the property management space, we will start to see some truly accelerated growth. I think this is a trend to keep a very close eye on.”

Todd Butler, Senior Vice President, Flexible Living, RealPage, focused on short-term rental platform Migo, points to “massive” NOI opportunities that owners demand – mixed with the residents’ need for flexibility to live/work/travel post-Covid – are now mutually at odds with “the way it’s always been done.”

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Source: Tech Companies Cast Their Eyes on Apartment Portfolios

https://www.creconsult.net/market-trends/tech-companies-cast-their-eyes-on-apartment-portfolios/

Apartment Players Are 'Holding Their Breath Despite Surging Rents

 

One leading apartment maintenance and construction distributor speaks out on pricing and inflation.

Even with the recent, steady rise in rents—by double-digits in many markets—that degree of revenue gains is unsustainable, apartment operator Mike Brewer, COO, RADCO Companies, Atlanta, recently said.

That brings the focus to expenses. And there’s not a lot of hope that prices will come down, or even what might bring them down, commented a vice president for one leading apartment maintenance and construction distributor last week.

 

“Distributors, manufacturers, and apartment operators are simply holding their breath right now,” they said. “There’s too much uncertainty with the economy, world events such as Ukraine and then some; and what happens if China suddenly shuts down and for how long. You might say things could get better with results from the 2024 US Presidential election, but even that’s too far and too much of a wild card.”

The distributor said that the supply chain is better but remains broken. Headwinds include recovery from events beyond just Covid, including weather, shortage of workers at ports and truck drivers; and not having the right technology needed to efficiently move containers along the path the best way possible.

Must Be Flexible on Brands

Apartment operators have said that they are left to be more flexible on product brands during this time, and this distributor described that predicament.

“You might want or need a Moen faucet, but then all of a sudden you can’t get it so you need to go with Pfister or some other brand. It’s unsettling, and appliances are the toughest product line to acquire right now, and for most of the past year or so.

 

“But we learned during the pandemic that our industry can be flexible and move on a dime. Manufacturers went from making a ton of faucets to making a ton of gloves.

“Let’s also remember that operators spent five years talking about self-guided tours, but didn’t do them. Then: Boom, they found a way to roll them out in a couple of weeks once lockdowns started back in 2020.

HVAC Systems Upgrades Coming

Upgrading and meeting changing regulations for HVAC systems and parts has created another difficulty.

“There are new regulations going into place right now where most jurisdictions are going to have to increase their SEER by one,” the distributor said. “Manufacturers are pausing some existing product-making as they transition to the new models. This will cause delays regardless of any other factor.”

And while pricing continues to be volatile, there are other factors in play that make pricing, availability, and now, budgeting, tough to figure.

“What we see is that the best customers can get the best prices,” they said. “Having existing strong relationships really does matter. We take care of our best customers, first.”

Passing on the Costs Hikes

The spokesperson said customers often ask how much of inflation the manufacturers and distributors pass along.

“If there’s a $40 item that now costs us $50, do we charge them that full extra $10,” they said. “And do we factor in other ongoing, rising inflation factors by pricing based on wages, gas prices, and anything else? The answer is, ‘It’s all variable, based on customer, item, and market?’

They said there also can be different prices for MRO vs renovation jobs.

“With a renovation job, we might have priced something six months ago and then that item goes way up in price,” they said. “Do we still honor it? If it’s a small customer or a small job, because we simply might not be able to eat that cost. It’s unfortunate.”

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Source: Apartment Players Are ‘Holding Their Breath’ Despite Surging Rents

https://www.creconsult.net/market-trends/apartment-players-are-holding-their-breath-despite-surging-rents/

2022 Multifamily REIT Results

Data as of May 5, 2022

Source: S&P Global Market Intelligence

US Equity REIT Average 2021 Q4 AFFO Payout Ratio Estimate

As of May 5, publicly traded U.S. equity REITs had an average 2021Q4 AFFO payout ratio estimate of 73.6 percent.

Among the sectors displayed in the chart, health care REITs had the highest average AFFO payout ratio estimate for the first quarter of 2022, at 84.4 percent. The multifamily and manufactured home sectors followed at 75.2 percent and 74.8 percent, respectively.

On the other end of the spectrum, self-storage REITs had a 73.9 percent average AFFO payout ratio estimate for the first quarter of 2022.

Among the multifamily REITs, Washington Real Estate Investment Trust was on top of the list with a 96.6 percent AFFO payout ratio estimate. Following next was Bluerock Residential Growth REIT Inc., with a 90.6 percent payout ratio estimate. Independence Realty Trust Inc. was at the bottom of the list with a 54.5 percent payout ratio estimate for 2021Q4.

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Source: 2022 Multifamily REIT Results – Multifamily Real Estate News

https://www.creconsult.net/market-trends/2022-multifamily-reit-results-multifamily-real-estate-news/

Big Boxy Apartment Buildings Are Our Rental Future

 

Rather than end the era of these large developments, the pandemic has confirmed their dominance in housing construction.

Amid the materials shortages, price hikes, and other craziness of the housing market last year, something remarkable happened. US builders completed more apartments in large multi-unit buildings than ever before.

Boom Times for Big Apartment Buildings

Units completed in US multifamily buildings of 50 units or more

Source: U.S. Census Bureau, Characteristics of New Housing

 

Yes, these numbers only go back to 1972, but with other statistics indicating that 1972-1974 marked the all-time peak in overall US apartment construction, it seems safe to say that the 214,000 housing units completed in buildings of 50 units or more in 2021 has never been surpassed.

This news, contained in annual Characteristics of New Housing data that the Census Bureau released with little fanfare earlier this month, may come as something of a surprise amid a pandemic that emptied downtown office buildings and brought real estate bidding wars to outer suburbs and mountain resorts. Big apartment buildings don’t really seem to match the moment.

One explanation for their continued boom is that to be completed in 2021, large apartment buildings generally had to have been in the works before the pandemic hit. According to the Census Bureau’s Survey of Construction, the average time from permitting to completion for multifamily buildings of 20 units or more that were finished in 2021 was about 19 months.

But that doesn’t explain what’s coming next: After dipping in 2020, the number of new units authorized in multifamily buildings took off, running 37% higher over the past 12 months than in the same period in 2018/2019.

Lots More Apartments to Come

New housing units authorized in US buildings of 5 units or more, monthly, at annual rates, seasonally adjusted

Source: U.S. Census Bureau, New Residential Construction

 

Apartment completions are now down a little, a reflection of that 2020 permitting slowdown, but that should turn around soon. We don’t know for certain how many of these new apartments will be in big buildings because the permit statistics don’t differentiate between 5-unit buildings and 50-unit ones. But over the past five years, housing units in buildings of 50 units or more accounted for 57% of all multifamily units completed, while those in buildings with 20 units or more accounted for 85%.

Bigger Apartment Buildings Take Over

Multifamily units completed by units per building

Source: U.S. Census Bureau, Characteristics of New Housing

 

During the apartment construction booms of the 1970s and 1980s, smaller buildings predominated. Now, multifamily buildings of four units or fewer are barely being built at all — the Census Bureau estimates that just 4,000 duplex units and 3,000 units in three-or-four-unit buildings were completed in 2021 — and those in the five-to-19-unit range have gone from mainstay of the US new-apartment supply to afterthought.

The disappearance of this “missing middle” between single-family houses and larger multifamily structures has been much lamented, and, as is clear from the above chart, the boom in big apartment buildings hasn’t been enough to fully make up for it. Still, apartment construction is now at levels not seen since the Tax Reform Act of 1986 wiped out key tax incentives for investment in rental housing. By contrast, overall housing construction — which consists mostly of single-family houses — is still at only about two-thirds of its 2006 peak.

Not Setting Any Overall Housing Construction Records

New US housing units completed, trailing 12 months

Source: U.S. Census Bureau, New Residential Construction

 

A longer, population-adjusted view shows the period from 2008 to 2015 to have been the weakest for US housing starts since World War II, and one of the weakest on record.

The Long View on US Housing Construction

New US housing starts per 1,000 population*

Sources: U.S. Census Bureau, New Residential Construction; Historical Statistics of the United States, Colonial Times to 1970

*Pre-1959 totals exclude farm housing, post-1934 totals exclude public housing

That housing construction bust happened just as the members of the largest US generation, the millennials, were entering adulthood. Not great timing! The current large-apartment-building boom, then, is occurring in the context of a housing supply that’s growing, but not fast enough to meet the demand that built up during that bust. And now it has taken new forms with the pandemic-era embrace of remote work.

The ability to cut loose from downtown offices and even large metropolitan areas has to some extent shifted demand away from expensive urban neighborhoods and coastal metropolises in general. But picturesque mountain towns can only accommodate so many newcomers, and physical and political barriers to building a lot more single-family homes are cropping up in large inland metro areas as well as coastal ones. It’s no shock that multifamily units make up the majority of new housing going up in and around New York, Philadelphia, Seattle, Miami, and Boston, but a bit surprising to see that the same is now true of the Austin, Denver, and Twin Cities metro areas, with Nashville not far off.

Where the New Apartments Are Going Up

Housing permits issued, by metropolitan area, 2021

Source: U.S. Census Bureau, Building Permits Survey

 

Other, smaller, metro areas where the majority of new housing units authorized in 2021 were in buildings of five units or more included Napa, California (86.3%), Missoula, Montana (73.2%), Santa Fe, New Mexico (72.9%); Madison, Wisconsin (72.8%); Boulder, Colorado (62.4%); and Rapid City, South Dakota (53.6%). It’s clearly not just a big-city thing. And while 50-plus-unit apartment buildings are probably a smaller part of the mix in these places than in larger metropolitan areas, the trend toward bigness has been pretty universal. Another way of measuring it is by how tall the buildings are.

Apartment Buildings Have Gotten Taller

Share of new multifamily units in buildings of four stories or more

Source: U.S. Census Bureau, Characteristics of New Housing

Most of those buildings probably aren’t much taller than four stories. According to Characteristics of New Housing data, 77% of the multifamily units completed in 2021 were in wood-framed buildings. While “mass timber” buildings of up to 18 stories are now allowed, “stick” framing similar to that used in single-family houses is the standard in US wood-framed apartment construction, and is subject to stricter height limits. The resulting proliferation of boxy, “five-over-one” apartment buildings with five wood-framed stories over a concrete first floor (or, if you prefer, Type V construction over Type I) is something I have written about at great length in the past and won’t go into here, other than to urge you to refer to them as “stumpies” because I think that’s a good name.

But why the shift from small apartment buildings to big? I don’t think consumer demand really explains it. Yes, a big building or complex can offer amenities such as pools, gyms, and concierges — not to mention views, if it’s tall enough — that a smaller one can’t, and there does appear to have been an increase in the number of affluent renters, many of them empty-nesters, who demand such amenities. Supply-side factors seem more important, though.

Getting housing built is harder than it used to be, partly because there’s not a lot of developable land left within large metropolitan areas (or even adjacent to them in some coastal metropolises) and partly because of the political and regulatory barriers to development have grown. That favors developers with lots of resources and expertise. As industries go, multifamily housing development isn’t all that concentrated — the 25 biggest US developers, as ranked by the National Multifamily Housing Council, accounted for a quarter of the multifamily housing starts in 2021. But even developers well below the top 25 go about their work in an increasingly professionalized and institutionalized manner, with syndicators, real estate investment trusts, and even sovereign wealth funds all playing a role. Building some duplexes on a vacant lot in a residential area isn’t really worth these people’s time. Building a 150-unit apartment building in a city or a suburban shopping district often is.

Will it continue to be? The annualized return on US apartment investments has been 9.2% over the past decade, according to the National Council of Real Estate Investment Fiduciaries, with a return for the four quarters ending in March of 24.1%. Rising interest rates and a slowing economy mean 2022 and 2023 won’t be nearly so lucrative — the Standard & Poor’s 500 Residential REITs Sub Industry Index is down 36% since April — and a construction slowdown is almost sure to follow. But the longer-term forces driving investment into big apartment buildings don’t seem to be going away.

 

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Source: Big Boxy Apartment Buildings Are Our Rental Future

https://www.creconsult.net/market-trends/big-boxy-apartment-buildings-are-our-rental-future/

Asking Rents Hit Record High

Asking rents are at an all-time high with year-over-year and month-over-month gains.

U.S. asking rents are at an all-time high, and in some metros, more than double the average growth. According to the latest research from Redfin, the median monthly asking rent was up 15.2% year-over-year (YoY) in May—marking the first time it has eclipsed the $2,000 threshold. The month-over-month increase was 2%, bringing the average monthly rent to $2,002.

In the months leading up to the onset of the COVID-19 pandemic, median rent hovered around $1,600, and this continued until mid-2020 when there was a slight spike; rent declined back in the direction of the $1,600 baseline toward the end of 2020 before starting on this continued growth path that has been seen since the start of 2021. In May 2021, year-over-year asking rents were up 4%, and asking rents were up 17% YoY in March 2022.

“More people are opting to live alone, and rising mortgage interest rates are forcing would-be homebuyers to keep renting,” said Taylor Marr, Deputy Chief Economist with Redfin, in a release. “These are among the demand-side pressures keeping rents sky-high. While renting has become more expensive, it is now more attractive than buying for many Americans this year as mortgage payments have surpassed rents on many homes. Although we expect rent-price growth to continue to slow in the coming months, it will likely remain high, causing ongoing affordability issues for renters.”

While overall asking rents have grown substantially, it is market-specific. The New York area, which includes the likes of Nassau County and New Brunswick, N.J., among others, had the highest median asking rent of just north of $4,000, a more than 24% increase YoY. Meanwhile, Austin, Texas, saw a nearly 50% jump in asking rent bringing the median asking rent to just over $2,700. Only three metros—Milwaukee (-10%), Kansas City, Mo. (-2.9%), and Minneapolis (-2.8%)—saw YoY declines in median asking rent.

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Source: Asking Rents Hit Record High

https://www.creconsult.net/market-trends/asking-rents-hit-record-high/