Net Operating Income Guide
NOI is short for net operating income and is a number that is used to calculate the profitability of an income-generating real estate investment such as a rental property. Property investors use NOI to analyze and compare investments as well as to calculate the cap rate of a property.
The benefits of calculating net operating income are that it provides excellent insight into the potential revenue a property can generate on an ongoing basis. This analysis is not only useful for investors but also for lenders as by calculating net operating income on a property, they can better determine whether or not the investor will have enough cash flow to make payments on their loan.
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How Do You Calculate Net Operating Income?
The net operating income on a property is simply the gross income it generates minus your operating expenses. Calculating NOI in real estate is relatively simple as it does not take into account capital expenditures, principal and interest payments, depreciation, or amortization. To calculate your net operating income, simply add your rental income and other income together and then subtract vacancy and losses and operating expenses.
Make sure not to forget any non-rent-related income the property generates when you calculate the total revenue the property brings in. This can include income from parking fees, on-site laundry machines, and vending machines.
Vacancy and credit loss refers to the rental income you don’t collect due to apartment turnover when tenants move as well as when they don’t pay any rent that’s owed. This is best estimated by looking at comparable properties and how they perform.
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Net Operating Income Formula
NOI = Gross Income — Operating Expenses
For example, let's say you have a duplex that brings in $2,000 a month in gross income, and that your operating expenses total $400 a month. To calculate your net operating income you'd take your annual gross income ($24,000) and subtract your operating expenses ($4,800). In this example, your NOI would be $19,200.
NOI = Rental Income + Other Income — Vacancy Loss — Operating Expenses
For example, let’s say you have a 10-unit property with each apartment renting for $1,000/month. Additionally, you rent 5 parking spots for an additional $100/month each. Your property has a 10% vacancy loss and $2,000 in monthly operating expenses. Here’s how you would calculate your NOI:
$120,000 (rental income) + $6,000 (Other Income) — $12,000 (Vacancy loss) — $24,000 (Operating expenses)= $90,000 net operating income.
As you can see, NOI is generally calculated on an annual basis, but it’s relatively simple to also calculate your monthly NOI by dividing this number by 12. In our example, the monthly NOI would be $7,500.
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What Are Operating Expenses In Real Estate?
Real estate operating expenses include all costs associated with maintaining the property and running the business. The main components of real estate operating expenses include property taxes, insurance, utilities, and property maintenance and upkeep expenses. This means that all costs associated with managing the property, from legal and accounting to contracted services like lawn care, cleaning, snow removal, and repairs, are operating expenses. When you consider that some of these expenses may be seasonal or only payable once per year, it makes sense why net operating income is calculated on an annual basis.
Capital expenditures, which are used to upgrade or enhance a property, are separate from operating expenses and are not included in NOI calculations. Marketing expenses can be both an operating expense or capital expenditure, depending on how necessary the marketing is for running the business. For example, any costs associated with listing an apartment online would likely be an operating expense. In contrast, the cost of building or upgrading your property website would be a capital expenditure.
Is a Mortgage Payment an Operating Expense?
No, a mortgage payment is not an operating expense. That means your NOI does not include your mortgage or any debt-related expenses. All that is included in your net operating income is your gross income minus your operating expenses. NOI lets you compare investments to one another regardless of if you purchased them all cash or financed and have a mortgage.
If you have a mortgage on a property, you might find it useful to calculate the cash flow instead of the net operating income as that takes into account all expenses, including debt payments. Cash flow is sometimes also referred to as net income.
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How To Interpret Net Operating Income
The net operating income of an income-producing property can give an owner or investor a very clear picture of the property’s potential cash flow. This is thanks to the fact that it is incredibly difficult to manipulate NOI. The only way to change the NOI on a piece of real estate is to increase the gross rental income or to cut operating expenses. Overall, you can use NOI to determine how well a property is being managed compared to comparable properties in the area or even in comparison to other properties you may own.
Another way to use NOI is for trend analysis to better understand how a property is performing. By looking at how a property’s net operating income has changed over time, you can see if it’s performing well or if the NOI is dropping, which might mean you need to take action to remedy the problem or even consider selling.
NOI is also a key component in the formulas for other important calculations, such as determining the cap rate or the debt service coverage ratio of a property. The cap rate can help you determine your expected ROI, while the DSCR will be used by lenders to evaluate your ability to meet your debt obligations. The formula a lender will use to calculate the DSCR is to take the property’s NOI and divide it by the debt service (mortgage principal and interest payments). For example, if a property has $90,000 in NOI and $45,000 in annual debt service, the DSCR is 2. Naturally, the higher the net operating income, the more favorably the lender will look upon the deal. Most lenders will also require a minimum DSCR of 1.20 or higher.
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Real Estate NOI Pros and Cons
While net operating income is a great metric to look at when determining whether or not to make a real estate investment, it’s not a perfect metric. Here are some pros and cons of using NOI.
Real Estate NOI Pros
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NOI can be used to quickly help investors determine a fair purchase value of a property.
NOI real estate formulas give investors great insight regarding what to expect from ongoing revenue.
The real estate NOI value is useful in helping lenders determine if the property represents a risky investment.
Real Estate NOI Cons
The NOI is prone to be inconsistent as it depends on how the property is managed.
If the projected rents prove to be inaccurate, the NOI will be impacted negatively.
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Net Operating Income Bottom Line
Net operating income is an important metric that can help investors better understand the potential income and risks of an investment. When it comes to real estate, NOI can be used to help evaluate if a property is a good investment or if it's risky. Although net operating income can provide a lot of insight into the cash flow and return of an investment, it's not a perfect metric and should be used in conjunction with other metrics such as cap rate.
What is NOI in Real Estate and How Do Investors Use It?
NOI is a key financial metric that real estate investors use when analyzing rental property. In this article, we’ll discuss some of the ways to help accurately calculate NOI, and look at real estate calculations that use NOI.
- NOI calculates the current and future potential profitability of a rental property.
- Different elements used to calculate NOI include potential rental income, vacancy loss, and operating expenses.
- NOI is a real estate metric that is difficult to manipulate because the calculation does not include debt service or mortgage interest payments.
- NOI is also used in other real estate calculations including cap rate and debt service coverage ratio.
What is NOI in Real Estate?
Net operating income (NOI) in real estate calculates the potential profitability of a rental property by comparing the property’s annual income after operating expenses to the market value or price of the property.
NOI in real estate is used to help predict how profitable a property might be, based solely on the income the investment generates. For that reason, net operating income does not include deductions for debt service or mortgage interest payments, capital expenses, or income taxes paid by the investor.
Because NOI does not include variable factors such as debt service, net operating income is less subject to manipulation based on the amount of leverage used compared to other real estate financial metrics such as cash-on-cash return.
By looking at a property’s current and projected NOI, a real estate investor can gain a better understanding of the potential annual cash flow of an investment compared to the cost of operating the investment.
NOI Formula
The basic formula for calculating NOI is as follows:
- NOI = Gross Operating Income – Operating Expenses
So, if a real estate investment has a gross operating income of $18,000 per year and operating expenses of $9,500, the NOI is $8,500.
However, many real estate investors reformulate the NOI calculation to factor in items such as other income sources (including pet rent, late fees, or appliance rent) and potential rental income lost due to vacancy.
By including other income and expense items, the NOI formula can be redefined like this:
- NOI = (Potential Rental Income + Other Income – Vacancy Loss) – Operating Expenses
These are the different elements used to more accurately calculate NOI:
Potential Rental Income
The total amount of income a property would generate if it was occupied 100% of the time and leased at a fair market rent compared to comparable properties.
Amount of potential rental income lost due to vacancy caused by tenant turnover or a tenant being evicted due to non-payment of rent. Some real estate investors use a pro forma vacancy rate equal to 5% of the potential rental income.
Effective Rental Income
The amount of rental income a landlord can reasonably expect to collect is calculated by subtracting vacancy loss from the potential rental income.
Other Rental Income
Income that is not part of the regular monthly or base rent, such as additional pet rent, roommate rent, appliance rent, laundry for apartment buildings, or late fees.
Gross Operating Income
Total of effective rental income plus other rental income.
Costs directly related to operating the property to collect the fair market rent and maintain the property value. Normal operating expenses include property management fees, property taxes, insurance, and maintenance and repair expenses.
Net Operating Income
NOI is calculated by subtracting the property operating expenses from the gross operating income.
Remember that NOI does not take into account operating expenses and costs that may vary from one investor to the next. Items such as income tax paid by an individual investor, debt service and mortgage interest, capital expenses, and depreciation are excluded from the NOI calculation.
The reason variable expenses like these are not included in NOI is to provide the investor with a clear idea of the amount of income a property could generate compared to the cost of operating the property.
How to Calculate NOI
Now let’s look at how to calculate the NOI of a single-family rental home using the above elements:
Potential Rental Income = $12,300
Vacancy Loss = <$615> (based on 5% of the potential rental income)
Effective Rental Income = $11,685
Other Rental Income = $240 (pet rent)
Gross Operating Income = $11,925
Operating Expenses = <$3,245>
Property Taxes = <$2,100>
Total Expenses = <$5,345>
Net Operating Income = $6,580
Operating Expenses vs. Other Expenses
Operating expenses in real estate are the costs directly related to operating the property to collect the fair market rent and to maintain the property in its current condition. They do not include costs to finance the purchase of the property or capital improvement costs that add value to the property.
Some of the main costs included in operating expenses include marketing and tenant screening costs, leasing and property management fees, repair and maintenance, property taxes and insurance, and utilities if paid for by the landlord.
Seasonal expenses such as snow removal, semi-annual servicing of the heating and cooling systems, and landscaping are also treated as normal operating expenses.
Because operating expenses (and sometimes gross operating income) can vary from one month to the next, NOI is normally calculated on an annual basis instead of month to month.
Debt service, mortgage interest payments, and capital expenditures made to upgrade a property and add value (such as replacing carpeting or installing a new roof) are other expenses that are not included when calculating NOI.
By excluding other expenses that vary from one investor to the next, NOI can provide an investor with a clear idea of the property’s current or future potential cash flow. NOI is also a good financial metric to use when comparing alternative investment options to one another, in large part because NOI is extremely difficult to manipulate compared to other financial calculations such as cash on cash return.
Many investors who use financing to purchase a property begin by calculating the NOI to understand the income the property generates without the use of leverage. Then, they calculate the property cash flow and cash on cash return by including all expenses — including debt service and mortgage interest payments – using different down payment and interest rate scenarios.
How Real Estate Investors Use NOI
NOI is used by real estate investors and lenders to calculate the capitalization rate, property value, and debt service coverage ratio:
The capitalization rate (also known simply as cap rate) is a financial metric that measures the current and future potential rate of return on an investment. The higher the cap rate is, the larger the potential return on an investment is.
Cap rate is calculated by dividing NOI by the property value:
- Cap Rate = NOI / Property Value
If the market value of a single-family rental home is $120,000 and the NOI is $6,580, the cap rate is 5.5%:
- $6,580 NOI / $120,000 Property Value = 0.0548 or 5.48%
The same cap rate formula can also be used to estimate what the value of a property should be based on the NOI and the cap rate:
- Property Value = NOI / Cap Rate
- $6,580 NOI / 0.0548 Cap Rate = $120,073 Property Value
You can also use the cap rate formula to calculate the potential NOI of a home by using the cap rate for similar rental properties in the same market:
- NOI = Property Value x Cap Rate
- $120,000 Property Value x 0.0548 Cap Rate = $6,576 NOI
This simple spreadsheet by Roofstock provides an easy way to view the potential financial performance of a given property. You can use it to forecast the potential return of a property. Simply enter some information to view projected key return on investment (ROI) metrics, including NOI, cash flow, cash-on-cash return, and cap rate.
Debt Service Coverage Ratio
Debt service coverage ratio (DSCR) is a calculation real estate investors and lenders use to determine if there is sufficient income to pay the mortgage. The larger the DSCR ratio is, the larger the safety margin is in the event that expenses are higher or income is lower than expected:
- DSCR = NOI / Annual Debt Service
If a single-family rental property has an NOI of $6,580 and the annual debt service (i.e. the total amount of principal and interest payments made over a 12 month period) is $4,590, the DSCR is 1.43:
- $6,580 NOI / $4,590 Annual Debt Service = 1.43 DSCR
Pros and Cons of Using NOI
Calculating NOI in real estate is a good financial metric to use when analyzing a rental property investment, but there are some drawbacks to consider as well:
- Using NOI in real estate offers a clearer picture of what an investor may expect from future revenues generated by the property.
- NOI is used by real estate investors and lenders to help determine how risky an investment is by comparing the annual NOI to the annual debt service.
- NOI can vary significantly from actual performance based on the thoroughness of tenant screening and how well the property is managed.
- If NOI is miscalculated by using inaccurate rent estimates, vacancy loss, or operating expenses, other financial calculations such as cap rate and DSCR will be impacted as well.
Jeff Rohde
Jeff has over 25 years of experience in all segments of the real estate industry including investing, brokerage, residential, commercial, and property management. While his real estate business runs on autopilot, he writes articles to help other investors grow and manage their real estate portfolios.
Расчет NOI
NOI или чистый операционный доход – это валовый доход на конец года за вычетом всех операционных расходов до начисления амортизации.
В данном случае, под операционными расходами понимаются все виды затрат, связанные с обеспечением нормального функционирования объекта имущества. То есть, такой его эксплуатации, которая позволит извлекать доход.
Под действительным доходом за год понимается прогнозируемый доход предприятия за вычетом всех факторов, способных оказать воздействие на получение прибыли субъектом хозяйствования. Расчет осуществляется по формуле:
Действительный валовый доход = Потенциальный доход + Дополнительный доход – Недополученный доход
Потенциальный доход предполагает прогнозирование прибыли в условиях сто процентной эксплуатации имеющегося имущества. В этот показатель не включаются возможные расходы и потери. Как правило, этот показатель зависит от площади эксплуатируемого помещения, а также от установленной ставки арендного платежа. Расчетная формула выглядит следующим образом:
Статья: Расчет NOI
Потенциальный доход = Арендная площадь в квадратных метрах • Арендная ставка за 1 квадратный метр
Например, при сдаче площадей торгового центра или бизнес-центра основной доход будет формироваться из арендной платы, а дополнительный доход принесут платежи за пользование инфраструктурой центра. В этом случае недополученная прибыль будет зависеть от загруженности центра, наличия свободных площадей.
Таким образом, общая формула вычисления показателя чистого операционного дохода составит:
$NOI$ = Потенциальный доход + Дополнительные доходы – Недополученная прибыль – Операционные расходы
Расчет NOI при эксплуатации имущества
NOI или чистый доход за год представляет собой рассчитываемую устойчивую величину. Этот показатель рассчитывается как доход от имущества за вычетом операционных затрат и резервов, но до момента выплат ипотечного кредита и начисления амортизации. Кредит по ипотеке, как правило, выплачивается из прибыли, так же закладывается в себестоимость продукции. Амортизация полностью включается в себестоимость. Если оценивается недвижимость, сданная в аренду, то расчет производится за первый год сдачи в эксплуатацию имущества, со дня проведения оценки.
Для расчета NOI необходимо соблюдать следующие этапы:
- Вычисление потенциального валового дохода, получаемого при сдаче недвижимости в аренду по рыночной цене. Расчет проводится с даты, наступившей после оценки имущества.
- Вычисление эффективного дохода. Для этого из потенциального валового дохода вычитают расходы, связанные с незагруженностью, потерями при сборе платы за аренду или в случае смены арендаторов.
- Далее из показателя эффективного дохода вычитают все потенциальные расходы за год. Сюда включают постоянные и переменные расходы, а также резервы.
Постоянные затраты предприятия не связаны с его производительностью и степенью загруженности. К ним относят обязательные страховые взносы или налоги. Операционные или эксплуатационные расходы включают в себя расходы, связанные с обслуживанием помещения, порядком предоставления имущества в пользование арендаторам, обеспечением потока доходов. Примером операционных расходов может послужить плата за коммунальные услуги, управление недвижимостью, зарплата и налоги на нее наемным рабочим, уборка помещения и близлежащей территории, оплата услуг аутсорсинговых служб, расходы на ремонт, содержание недвижимости, представительские расходы.
Практическое применение показателя NOI
Показатель чистого операционного дохода часто используется предприятиями для определения влияния операционных расходов на итоговый показатель прибыли. С его помощью, руководство может отследить сферы деятельности предприятия, которые не приносят желаемый доход или не рентабельны.
Большинство современных субъектов хозяйствования стремятся к реализации собственной экономики таким образом, чтобы максимально увеличить доход в существующих условиях. При этом снизить свои постоянные и переменные издержки до уровня, позволяющего сохранить приемлемый уровень качества продукции. Расчет показателя NOI позволяет понять, работает ли компания на максимально эффективном уровне. Если показатель не устраивает руководство, то необходимо предпринимать изменения в работе предприятия, которые позволят повысить эффективность и снизить операционные расходы. В итоге это приведет к росту NOI, а значит, позволит компании покрывать и неоперационные расходы, например, проводить своевременную выплату процентов по заемным средствам и другое.
NOI позволяет отследить тренд, характерный для компании. Его снижение от одного исследуемого периода к другому, свидетельствует о том, что необходимо изучить причину этой тенденции. Анализ слабых сторон позволит сохранить функционирование компании, ее платежеспособность и финансовую независимость. Некоторые компании пользуются трендами, чтобы исказить реальное положение дел компании для разных целей. Например, с помощью манипулирования чистым операционным доходом появляется возможность снизить обязательные платежи в бюджет, либо предоставить инвесторам искаженные данные. Подобное манипулирование обычно укладывается в рамки действующего законодательства, но противоречит этике предпринимательства.
Таким образом, показатель чистого операционного дохода позволяет не только прогнозировать работу предприятия, рассчитывая его планируемую прибыль, но и вычленять текущие проблемы компании. Определение слабых сторон позволяет предпринимать шаги по увеличению эффективности эксплуатации имущества, а значит, снижению текущих операционных расходов.
Understanding NOI/Cap Rate & How to Calculate Them
Real estate investments are one of the most popular forms of investment vehicles available. They are tangible, offer a hedge against inflation, and are a great way to diversify your investment portfolio. In fact, many investors can earn lucrative returns from investing in real estate, especially if they invest in the right location for their chosen investment strategy.
While one can earn gainful profits from real estate, not all investment properties offer the same level of profitability. The location of the investment property, as well as the investment strategy used, can significantly affect your success. To be successful, you also need to study the income potential of a real estate investment first before you decide to buy any investment property.
Various metrics can help you assess an investment property’s profitability, and two such metrics are the net operating income (NOI) and the capitalization (cap) rate. NOI refers to the difference between the property’s income and expenses. On the other hand, cap rate refers to the rate of return based on the NOI and the property’s value or sales price.
Knowing the NOI/cap rate of a real estate property can help you determine whether it will make a good investment or not. While it may sound simple, calculating the NOI and cap rate should involve thorough real estate data research so you can generate accurate results. In this article, we will learn more about NOI/cap rate and discuss efficient ways to calculate them.
What Is NOI?
NOI, short for net operating income, is one of the important metrics that can help you determine whether a real estate investment will be profitable or not. NOI refers to the net income from all revenues generated from the investment property less all necessary operating expenses.
Many people wonder what does NOI stand for in business, especially in real estate. In general, NOI helps you determine the cash flow of an investment property. It shows whether your business generates more inflows (from all sources of revenues) than outflows (from the business’s operating expenses).
To calculate the NOI accurately, you need to first consider all income sources related to your real estate investment. Remember that aside from rental income, your real estate investment will also generate revenue from other sources, including:
- Parking fees
- Cleaning fees
- Fees for other services
- Extra charges for amenities
- Sales from vending machines
- Laundry facilities
After you determine the revenues an investment property makes, the next thing that you must do is to identify all reasonable operating expenses related to the real estate investment. The expenses include the cost of running and operating the real estate business, such as:
- Utilities
- Property taxes
- Repair and maintenance costs
- Insurance premiums
- Accounting and legal fees
- Property management fees
- Janitorial fees
- Marketing expenses
Gross Operating Income
To get an accurate NOI calculation, you need to determine the gross operating income of an investment property first. The formula for calculating the gross operating income is as follows:
Gross Operating Income = Potential Rental Income — Vacancy Losses
Keep in mind that if you invest in a rental property, you need to take into account the possible fluctuations in your rental income. There are times when your property is vacant, which means it will not generate income. Taking the vacancy rate into consideration is crucial to get an accurate NOI figure.
Potential Rental Income
The potential rental income from an investment property refers to how much a property makes if you achieve a 100% occupancy rate. For instance, if you report a monthly rental income of $2,500, then in a year, it can generate a potential rental income of $30,000. It is the best-case scenario for the investment.
Vacancy Rates
While it is ideal to get your investment property rented out 100% of the time, it is not always the case. That’s why it’s crucial to factor in the vacancy rates when calculating your gross operating income. However, finding the vacancy rates of an investment property can be difficult. You need to conduct rental comps analysis to find the vacancy percentage you should use.
Based on our example above, let’s say the lease agreement is just for 10 months, and you don’t get to rent out the property for two months. So, your annual gross operating income is $30,000 minus $5,000 (which is two months’ worth of missed rent due to vacancy) or equivalent to $25,000.
What Expenses Are Not Included in the NOI Calculation?
Certain expenses related to your real estate investment should not be included in the NOI calculation. In general, NOI should not include expenses that can be written off, as well as taxes and large one-time costs, like capital expenditures. We exclude such expenses in the NOI calculation because they do not support the true cash flow of the investment property.
The true cash flow of a real estate investment should be able to provide insights into how profitable a property is and how much it costs to operate and maintain the investment. The NOI should be able to show you the overall health of your real estate investment based on its cash inflows and outflows.
To provide the true cash flow of an investment property, the NOI calculation does not include the following expenses:
Income Taxes
We consider the net operating income a pre-tax calculation, which means that we do not take into consideration taxes in the calculation.
Depreciation
Depreciation is an accounting concept, not an actual expense. Since there is no actual cash or money flowing out of the business when you write off the value of something, it is excluded from the NOI calculation.
Mortgage Amortization
We do not take mortgage payments into account when calculating NOI because debts are not included in the calculation. Since mortgage payments can vary from one investor to another, it will significantly impact the NOI results if included.
The purpose of calculating NOI is to determine the overall health of the investment, regardless of whether you will acquire the property through a loan or not. It is why debt service is excluded from the NOI expenses. By excluding it, we can compare investment properties based on their cash inflows and outflows alone.
Capital Expenditures
We also exclude large one-time expenses, such as renovation costs and costs of equipment, when calculating NOI. It is because, in most cases, capital expenditures are not paid using the income generated from the investment.
Usually, business owners finance their capital expenditures either through cash reserves or other forms of financing. Since capital expenditures do not directly affect the cash flow of the business, the NOI formula omits them.
The NOI Formula
The formula for calculating NOI is pretty straightforward and you can use this to manually compute an income property’s NOI:
NOI = (Gross Operating Income + Other Income) — Operating Expenses
We’ve discussed how to calculate the gross operating income and which operating expenses are included in the NOI calculation. As mentioned, aside from the income that a property generates from rent, you also need to consider the property’s other income streams as long as it provides cash inflows to your business.
An investment property can earn income outside of monthly rent payments from tenants, such as parking fees, laundry services, pet fees, and sales from laundry machines. Whatever money the property makes on top of rent should be taken into account when calculating the NOI.
NOI Sample Calculation
Let’s say you’re evaluating a duplex rental property that generates a rental income of $2,000 per month per unit. Your potential rental income per year for both units is $48,000. The property also generates a total of $1,500 per year in additional income outside of rent. The total annual operating expenses for the property is $37,000.
Given the above figures, the NOI of the property is as follows:
NOI = ($48,000 + $1,500) — $37,000
If, for instance, the operating expenses are higher than the sum of gross operating income and other income, it will result in a negative NOI, which is essentially a net operating loss (NOL).
What Is Cap Rate?
The cap rate, short for capitalization rate, is another rate of measure that determines the profitability of an investment property. It is calculated based on the property’s NOI and sales price and is typically expressed as a percentage. Calculating the cap rate of a property helps prospective investors decide whether or not it is worth investing in.
In general, cap rates are useful for comparing multiple investment properties to help you decide which one will make the most profits. It can help you estimate your potential return on investment. However, it’s worth noting that using the metric alone to evaluate the profitability of an investment property is not recommended.
Using cap rates as the sole indicator for finding a property’s income potential may not be efficient as it does not take into account the financing method used for acquiring the property. Plus, it does not consider the future improved value of the property should you perform certain renovations.
The Cap Rate Formula
You can easily calculate the cap rate of a certain investment property using a cap rate calculator. You can also do it manually using the simple formula below:
Cap Rate = Net Operating Income / Property’s Sales Price or Market Value
Using the above formula, you can estimate how much a property can make over a one-year period. The cap rate metric is best used if you purchase the property in cash, as it does not take into account the method of financing you use.
The first factor needed for calculating the cap rate is the property’s net operating income, and we’ve already discussed what it is and how to calculate the NOI. After you determine the NOI of a property, you can use that figure to find out its cap rate.
The second factor used for calculating the cap rate is the property’s selling price or current market value. You can use the present-day value of the property based on the current market rates, or you can also use its listing price.
Cap Rate Sample Calculation
For example, you’re evaluating a rental property that’s listed at $512,000 and generates an annual net operating income of $12,500. Using the cap rate formula above, the cap rate for this particular property is as follows:
Cap Rate = $12,500 / $512,000
Based on our example, the cap rate of the rental property is 2.44%. The next question is, is it worth investing in?
What Is Considered a Good Cap Rate?
Based on the formula, the cap rate will generate a higher value if the subject property shows a higher net operating income and a lower valuation or listing price. In contrast, it will generate a lower value if the property’s NOI is low and the valuation or selling price is high. But the question is, what is really a good cap rate?
Keep in mind that what makes a cap rate “good” depends on various factors, and the ranges for a good cap rate are not set in stone. Most real estate professionals believe that a cap rate between 8% to 12% is considered good; however, the said range does not apply to all properties. In some cases, investors find cap rates of at least 2% acceptable.
How Do Cap Rates Determine Risks?
Aside from helping you find the best investment property to buy, cap rates are also used to determine how high a property’s investment risk is. Sometimes, properties with higher cap rates involve higher risks. In this case, high doesn’t always equal “good.”
Generally, how good or bad a cap rate is will largely depend on the real estate market where you invest in. For example, we look at two similar properties located in different geographical areas. One is located in a big city, while the other one is in a remote location.
The first property located in a large city will likely generate a higher income compared to the one in a remote area. However, the property in a city will likely incur high expenses and maintenance costs as well. So, you can expect properties in big cities to come with lower cap rates.
But it does not mean that the property will not make a good investment. In fact, the lower cap rate value indicates that the property shows a better valuation and may appreciate in value more quickly. Therefore, it comes with a lower risk.
On the other hand, the property located in a remote area with a higher cap rate may indicate that the property’s value may not appreciate as quickly. Depending on where the property is located, a high cap rate is usually also associated with higher risks.
The Most Efficient Way to Calculate NOI and Cap Rate
After learning what NOI and cap rate are, let’s find out what is the most efficient way to calculate both return metrics.
Based on the formula for NOI/cap rate, you can easily compute the value of both metrics if you obtain all the needed information for your real estate analysis. So, the challenge here is not really about calculating the figures but more about finding the data that you need.
Note that it takes thorough research to get accurate values for rental income, vacancy rates, other income, and operating expenses. Doing this process manually is time-consuming and generally prone to error. Fortunately, the rise of advanced technology allows real estate investors to conduct proper rental analysis without doing any manual research.
Real estate platforms like Mashvisor provide all the necessary tools that investors need to help them make the right investment decision. Mashvisor is the most reliable real estate analytics platform when it comes to providing up-to-date and realistic computations to help investors determine a property’s profitability.
Here are the Mashvisor tools that you can use to find whether or not an investment property will be worth your time and money:
Market Finder
Mashvisor’s Market Finder allows you to easily determine the best real estate markets for your chosen investment strategy. For example, if you’re planning to buy an Airbnb for sale , you can search for the best short term rental markets through the Market Finder. You can set your custom filters based on cap rate, home value, property type, income, or occupancy rate.
You can also choose the state where you plan to invest in, and you’ll see the top markets based on either Mashmeter score, rental revenue, cap rate, or crime rate. The Mashmeter score is an evaluation scoring system provided by Mashvisor’s machine-learning algorithm and AI technology to determine the market’s investment potential.
Property Finder
Let’s say you’ve determined the best rental market to invest in with the help of the Market Finder. You can then take advantage of Mashvisor’s Property Finder tool to see the listings for sale in your chosen market. You just need to enter the city or neighborhood of your choice and set filters such as budget, rental strategy, and property type.
You’ll then be provided with a list of results of properties for sale based on the criteria that you set. It allows you to easily find the right investment property that matches your criteria. The Property Finder tool is what sets Mashvisor apart from most other real estate platforms available online. Most other platforms do not allow users to search for properties for sale.
Investment Property Calculator
Once you find a property that you like, the next tool that can help you determine whether that property will make a good investment or not is Mashvisor’s investment property calculator. The tool is what’s going to help you find the NOI/cap rate and other rates of measures to determine the property’s return potential.
Aside from NOI/cap rate, you’ll also see the cash on cash return of the property. The CoC return metric determines the profitability of an investment property based on the NOI and initial cash invested. Unlike the cap rate, the cash on cash return takes into account the method of financing used for acquiring the property.
Using Mashvisor’s real estate investor calculator, you’ll easily get the figures for NOI/cap rate without doing your own research. Plus, you can rest assured that the real estate data provided is accurate and updated. What’s more, the calculator is interactive, so you can adjust certain figures like expenses, occupancy rate, nightly rate, and mortgage information.
If you’re ready to find the best investment property, sign up for a 7-day free trial with Mashvisor today.
Use NOI/Cap Rate to Find the Right Investment Property
Calculating the NOI/cap rate of an investment property is crucial for evaluating the property’s income-earning potential. The two metrics can help you make the right investment decision so you can easily avoid high-risk investments. It’s important to note, however, that NOI and cap rate should not be the only metrics to consider when finding the right investment.
While calculating the NOI/cap rate can be done manually, it would take a lot of time on your part to do research. Plus, it can be prone to error, too. That is why it’s best to use a reliable online rental calculator to get the accurate real estate data that you need. When it comes to the best investment property calculator available, nothing can beat Mashvisor.
Mashvisor’s calculator will not only provide computation for NOI/cap rate but also for other metrics, such as cash flow, occupancy rate, and cash on cash return. In addition, you will see a side-by-side computation for both short term and long term rental strategies. The comparison makes it easier for you to determine the best strategy for your chosen property.
Learn how Mashvisor works. Schedule a demo today to see how the platform can do wonders for your real estate venture.