Tag: Cap Rate

What Is Net Operating Income?

Net Operating Income is a measure of the business’s profitability from operations. It is the Income after deducting operating expenses but before deducting depreciation, amortization, interest and income taxes. It is also known as Earnings Before Interest and Taxes (EBIT).

As an example, let’s look at an apartment building with the following income and expense figures:

  • Gross Rental Income: $160,000
  • Laundry Income: $3,000
  • Management expense: $16,000
  • Utilities expense: $25,000
  • Maintenance expense: $35,000
  • Property Tax expense: $12,000
  • Insurance expense: $6,000
  • Depreciation expense: $45,000
  • Mortgage Interest expense: $60,000

The Net Operating Income would be $69,000 (160,000 +3,000 – 16,000 – 25,000 – 35,000 – 12,000 – 6,000)

Net Operating Income is part of the calculation of the cap rate which we covered last week. It is also used to calculate the debt service coverage ratio (DSCR) which we’ll cover next week.

Capitalization Rate (or “cap rate”) is a ratio used to calculate the value of an investment by looking at the annual net operating income as a percentage of the property’s cost. Cap rate is calculated as Net Income divided by Current Market Value.

For Example: If a building is worth $1,000,000 and has a net operating income of $100,000, then the cap rate is 10% (100,000 divided by 1,000,000.)

You can also use this formula to calculate the value of a property.

Since Cap rate = Net Income / Market Value,
then Market Value = Net Income / Cap Rate.

Thus, if an investor wants a cap rate of 11% on a building that’s generating $80,000 in net operating income, we would value it at $727,272 ($80,000 divided by 0.11)