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.
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