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Net Operating Income (NOI)

Blog by Andrew Reid | February 9th, 2021

Net operating income (NOI) is what remains after one subtracts all the operating expenses on the pro forma. As simple as it sounds, NOI is perhaps the most important line item on a pro forma because it is used to calculate the cap rate, which determines the value of the property and DSCR. NOI does have its failings; specifically, it does not reflect account reserves for essential capital expenditures, thus distorting the property’s income and value, and increasing risks for both the property owner and lender. This drawback can be resolved by subtracting Capex from NOI and focusing on the property-before-tax cash flow (PBTCF), which will give investors and lenders a more accurate property valuation (Geltner, et al., p 239). The main reason NOI is an integral metric in the investment business is that it not only determines the going-in cap rate, but also the going-out-cap rate, which in turn determines the success or failure of the real estate venture (Geltner, et al., p. 240).  By focusing on increasing the NOI between acquisition (going-in cap rate) and the disposition (going-out cap rate), an investor can increase a property’s value and their ROI on disposition.