When commercial real estate (CRE) investing, it is imperative to understand and calculate net operating income (NOI) to help determine the profitability of an investment property. Put simply, to calculate NOI, subtract the day-to-day operating expenses from the income a property produces. However, what if you decide to invest in an absolute triple-net (NNN) lease property where there aren’t any operating expenses? NOI becomes pretty straightforward! Here is a synopsis of how to calculate NOI for general commercial properties, what figures to use for these types of properties, and how NOI plays a role in the capitalization rate (cap rate) and financing.
What Is Included in NOI
To determine NOI for traditional CRE and certain net-lease properties, calculate pre-tax revenue on rent received and any other income (i.e., parking structures/fees, vending machines, laundry facilities, game rooms) then subtract expenses. Expenses include all costs of running and maintaining the building and property, as well as insurance premiums and legal fees, salaries and wages, utility payments, property taxes, common area maintenance (CAM) fees, vacancies, property reserves, and more.
Operating Expense Examples
- Liability and insurances
- Legal and accounting fees
- Real estate and other taxes
- Landlord’s administration costs
- Property management/wages
- Water/sewer, gas, electric
- Plumbing and electrical maintenance/repair
- HVAC/furnace maintenance/repair
- Trash removal
- Snow removal
- Building maintenance, painting, repairs
- Parking lot striping, repair, refurbishment, lighting
- Janitorial and pest control services
What Is Not Included in NOI
Capital expenditures, such as a new roof, windows, or a heating and air-conditioning system, are excluded in this formula, as are principal and interest payments on loans, depreciation, and amortization. These items do not impact the potential to make income, so they’re not included in NOI.
Cap Rate & Financing
Determining a true NOI is essential when evaluating commercial property. When pricing a NNN property, the appropriate cap rate is applied to the NOI. A higher cap rate typically equates to a larger ROI but may also indicate a bit more risk. A lower cap rate usually equates to less ROI, as well as potentially lower risk. (Cap rate is not the same as the cash-on-cash return, which is pre-tax cash flow divided by the total amount of cash invested).
For financed properties, lenders use NOI to ensure a property’s income covers its operating expenses and debt payments (the debt coverage ratio – DCR) and to forecast cash flow. NOI is also used to calculate the net-income multiplier, cash-on-cash (CoC) return, and total return on investment (IRR). There are other balance-sheet details and financial decisions that can be explained by your buyer’s advisor and financial team once you narrow your search to a few select properties. If you are just beginning your property search, the simple calculation of NOI and cap rate gives you a measurement to assess properties and a solid idea of which ones best fit your objectives.
NNN Lease Properties & NOI
The very nature of absolute NNN lease properties excludes any landlord responsibilities or expenses. This is one reason Westwood Net Lease Advisors highly recommends NNN investments. The tenant agrees to a long-term lease (10 to 20 years) that requires paying the “net” amount for three types of costs – net real estate taxes on the leased asset, net building insurance, and net common area maintenance.
Most often, these tenants are corporate retailers such as Walgreens, Dollar General, or McDonald’s. They want control of all aspects of the property for uniformity across their brand. They perform their own maintenance, use their own vendors, and pay for all capital expenditures, providing a straightforward NOI – income from rent – in addition to other numerous advantages.
- Expense-free, stress-free ownership with long-term, guaranteed income.
- Passive, monthly income shaped to fit geographical preferences.
- Reliable, low-risk investment.
- Preservation of wealth and stable investment diversification.
- Annual tax benefits that can add as much as 2-3% to the published cap rate.
If you already own rental properties that require hands-on management and significant operating expenses, it may be time to let go of the headache of high-maintenance investments and earn a comparable income without the hassle. When you trade-up to a NNN property (or properties), you can defer all capital gains taxes with a §1031 exchange and earn a stable monthly income while you continue to work or enjoy life in retirement.
To Wrap it Up –Calculate NOI for the Right CRE Investment
As you contemplate your goals for a CRE investment, first consider the many pros and cons of traditional commercial properties versus responsibility-free NNN lease properties. Then determine the NOI and cap rates for each property that you are interested in to get a feel for which ones would be right for your financial and lifestyle objectives.
Not sure where to start? It is easy to consult with a trusted buyer’s advisor at Westwood Net Lease Advisors to learn more. At no cost to you, we get to know you and learn your goals, use our extensive industry network to locate the perfect property selection for you, perform cap rate, NOI, and other important calculations, and represent you all the way through closing. Contact us today for a no-obligation, complimentary consultation and get the NNN investment that’s right for you. 314-997-5227.