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In this email, we’re going to unpack one of the most important metrics you’ll find in real estate: NOI.

NOI stands for NET OPERATING INCOME — and you’ll use this measure throughout your career, so you better get familiar with it.

What is NOI and why does it matter?

This term is an important measure because each investor may get different debt terms and thus debt payments. NOI is the profit a real estate asset makes BEFORE you consider the debt service payments.

NOI calculates how much money a real estate asset profits without considering interest, principal, depreciation, capital expenses, etc. It is the EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) of real estate. NOI is a key indicator of overall financial performance.

Here’s the formula:

Total revenue - operational expenses = Net operating income (NOI)

What expenses are classified as operational expenses?

• Property management fees
• Utilities
• Property taxes
• Insurance
• Repairs
• Maintenance
• Marketing
• Snow removal/lawn care
• Payment processing fees

Aside from these expenses, this would be the same for anyone who owned property, actual "cash flow" (or how much cash ends up in an investor's pocket) on any given asset depends on a number of factors that are deal-dependent.

One of those deal-dependent factors is leverage. If I own a 1 million dollar building with a $750k mortgage on it at a 5% interest rate, my cash flow will be very different from someone who owns the building with no debt and slightly different from somebody with the same loan but a 25-year amortization schedule vs. a 20 year. There are a ton of variables and NOI helps account for each one.

Here’s a common question:

After — because the interest expense is deal-dependent, and the operations of the real estate asset do not depend on the debt factors.

Other items not included in the NOI calculation because of deal-dependence:

• Income taxes
• Financing fees
• Principal payments
• Interest payments
• Fund management fees (charged by whoever is overseeing the capital, not the deal)

Think about NOI like this:

If it is a required operational expense for anyone who could possibly own a piece of real estate - it comes out before NOI is calculated.

Expenses included in the direct operation of a real estate business—and included in the NOI calculation—are called "above the line" expenses. This phrase refers to expenses that are above the NOI line on a profit and loss statement.

If the expense is deal-dependent or could be a third-party fee not directly associated with operations, it comes out "below the line," and is not included in the NOI calculation.

NOI is used to determine the price, value, and health of a real estate investment because it is consistent across owners.

Next week I will cover the basics of the Cap Rate, which is calculated as the ratio between the NOI and the original capital cost or overall value of an asset.

Until then, onward and upward!

Nick