Net Operating Income (NOI) is a crucial metric for real estate investors, providing an objective way to compare the income and expenses of different properties. In addition to its primary use as a tool for evaluating profitability, NOI is also an essential component of the capitalization rate (cap rate) calculation, a key metric for assessing investment potential. The cap rate is determined by dividing the NOI by the property's purchase price, making it a fundamental part of the investment evaluation process. The best way to understand the components of these important calculations, is to illustrate a potential transaction scenario described below.

Scenario:

Investor A is interested in purchasing an industrial property at a current market price of $750 million dollars. The prospective buyer has estimated the Gross Operating Income to be $85 million dollars with Other Income equal to $5 million dollars. The annual Operating Expenses are projected to be $30 million dollars.

Purchase Price: $750,000,0000

Gross Operating Income: $85,000,000

Other Income: $5,000,000

Operating Expenses: $30,000,000

What is the Net Operating Income?

Net Operating Income = (Gross Operating Income + Other Income) - Operating Expenses

Gross Operating Income (GOI) considers the potential rental income of the property, adjusted for the vacancy rate, as well as all other sources of income generated by the property, such as vending machines, parking lots, and coin laundries (Other Income). 

Operating Expenses (OPEX) consists of property taxes, insurance, maintenance, repair costs, and fees like property management and marketing. However, certain items such as one-time expenses, tenant-specific improvements, and accounting-based depreciation are typically excluded from NOI calculation. Additionally, debt service and taxes are also frequently excluded given they vary among investors.

For example, the NOI for Investor A’s potential purchase of the industrial property is illustrated below.

($85,000,000 + $5,000,000) - $30,000,000 = $60,000,000 (Net Operating Income)

What is the Capitalization Rate?

Capitalization Rate = Net Operating Income/Purchase Price

The cap rate calculation is an assessment of the expected yield of a property over one year. Investors can quickly assess the potential profitability of a particular investment. A higher cap rate generally indicates a higher risk investment, while a lower cap rate suggests a more stable investment. For example, the cap rate calculation for Investor A’s potential purchase of the industrial property is illustrated below.

$60,000,000 / $750,000,000 = 8% (Cap Rate)

Interested in learning more about cap rates, check out this article.

Where to learn more about the Commercial Real Estate Industry in LATAM:

SiiLA is a leading real estate information platform in Latin America providing accurate data on the commercial real estate market. The SiiLA Market Analytics platform includes transactional information such as sales and rental prices, as well as capitalization rates for industrial, office, and commercial properties. For those interested in enhancing their real estate knowledge, SiiLA ACADEMY offers a flexible certification program designed by industry experts. Contact SiiLA for more information.