The task of making a profit from a real estate investment rests on the ability to earn more than you spend. Two key terms we use to analyze revenues and expenses are net income and net operating income (NOI). While both are indicators of profit and loss, NOI comprehends only your operational efficiency. On the other hand, net income incorporates all factors that contribute to a profit. Truthfully, both are essential elements for reporting and managing the financial condition of a real estate project.
In this article, we’ll describe how to calculate net income and NOI using the net income formula. Equally important, we’ll show how to calculate net income from a balance sheet and from an income statement. Additionally, we’ll see how the real estate income statement is specialized to report information related to rental properties. Finally, we’ll review a helpful example and answer some frequently asked questions.
What is Net Income and NOI?
Let’s look at the characteristics of both terms before we discuss how to calculate net income and NOI.
Characteristics of Net Operating Income
Moreover, in the context of real estate, NOI represents how well you operate your properties. In other words, it shows you whether you collect enough revenues to pay for all necessary operational expenses. Specifically, property revenues include rents, as well as various fees for maintenance, servicing, parking and so forth. Normally, you exclude property sale gains (and losses) from NOI because they are usually singular, non-recurring events. However, if you operate a fix-and-flip business, you should include gains and losses in NOI.
Operational expenses include:
- Maintenance costs (indoor and outdoor, including snow removal)
- Fees paid to a property management company
- Property taxes
- Janitorial fees
- Other expenses
However, NOI ignores specific expenditures:
- Interest: You want to analyze a property’s operations independently of its capital structure. That is, the relative amounts of debt and equity shouldn’t affect the operation of the property. Rather, you can decide how much debt to take on separately from how you operate your properties.
- Income Taxes: Your income tax bill relates to your net income rather than your NOI.
- Depreciation and Amortization: These are non-cash expenses that you accumulate on a balance sheet. These items are essentially for income tax preparation and reporting. They are not real-world expenses. In addition, properties typically appreciate over time, making amortization and depreciation less meaningful.
- Capital Expenditures: These create assets that reside on the balance sheet rather than as expenses on the income statement.
- Company Overhead: These are expenses arising from the company that owns the properties. Similarly, it includes indirect labor costs for accounting, legal, marketing and other functions. Additionally, it covers items like office supplies, data processing costs and so forth.
- Management Incentives: Properties, like hotels, might provide bonuses to managers who perform well. However, you’ll exclude these costs from NOI.
You will sometimes encounter the term EBITDA, which stands for earnings before interest, taxes, depreciation and amortization. Obviously, it is like NOI, except that we use EBITDA when measuring performance of companies rather than properties.
Characteristics of Net Income
Net income encompasses all revenues and expenses, not just operational ones. That is, it includes all the revenues and expenses that we excluded from NOI. We also call it net income, profit or the bottom line. At the end of the reporting period, you add net income to (or subtract net loss from) retained earnings. The balance sheet reports retained earnings, which owners can use to draw funds from the business.
How to Calculate Net Income and NOI
It will help to understand how to calculate net income and NOI by discussing the income statement for properties. Real estate income statements are somewhat specialized to reflect the industry’s workings.
Real Estate Income Statement
The following is a representative format for a real estate income statement. Pluses (+) and minuses (-) indicate whether items increase or decrease net income.
INCOME STATEMENT FORMAT
Effective Rental Income
Rental Income (+)
Gain/Loss to Lease (±)
Gross Potential Income
Vacancy (-)Delinquency/Credit Loss/Bad Debt (-)
Total Rental Income
Late Fee Revenue (+)
Other Resident Revenue (+)
Total Other Income
OPERATING EXPENSES (-)
Repairs and Maintenance
Total Variable Expenses
Real Estate Taxes
Total Fixed Expenses
TOTAL OPERATING EXPENSES
NET OPERATING INCOME (NOI)
NON-OPERATING EXPENSES (-)
TOTAL NON-OPERATING EXPENSES (-)
TOTAL EXPENSES (-)
GAINS (LOSSES) (±)
EXTRAORDINARY ITEMS (±)
As you can see, the statement has revenues on top, followed by operational expenses, non-operational expenses, gain/losses and extraordinary items. The statement reports NOI and net income.
How to Calculate NOI
The components of the NOI calculation are:
Rental Income: This is the potential rental income you would earn with no vacancies and all units making timely payments.
Gains or Losses to Lease: This represents any differences after an initial lease expires. Henceforth, it simulates renewals or new tenants with rents above or below the previous rental income.
Gross Potential Income: This equals the potential rental income adjusted by gains or losses to lease.
Vacancies: The potential revenue lost due to vacancies.
Concessions: The potential revenue lost due to concessions such as a free month of rent and/or parking.
Delinquency/Credit Loss/Bad Debt: Losses due to an inability to collect the full rent.
Total Rental Income: This equals gross potential income minus vacancies, concessions and delinquency/credit loss/bad debt. It is the cash you actually collect from tenants.
Other Income: Non-rental income from various sources, such as laundry, parking and late fees.
Total Income: Equal to total rental income plus other income.
Variable Operating Expenses: These include direct labor, utilities, supplies, pest control and other variable costs directly tied to operations.
Fixed Operating Expenses: These include property tax, insurance and management fees.
Total Operating Expenses: The sum of variable and fixed operating expenses.
Net Operating Expenses: Total income minus total operating expenses.
Normally, you generate a new income statement every month. You can also generate quarterly and annual versions.
How to Calculate Net Income
The income statement supports the net income formula, which uses the following items:
Non-Operating Expenses: As we detailed earlier, non-operating expenses include interest, income taxes, depreciation and amortization, among others.
Total Expenses: You calculate this by adding together operating and non-operating expenses.
Gains/Losses: These are the capital gains or losses you experience from selling properties.
Extraordinary Items: These are one-of-a-kind events that don’t fit other categories.
Net Income: This equals total rental income minus total expenses, adjusted for gains/losses and extraordinary items.
Clearly, the net income formula encapsulates all your revenues and expenses. As previously mentioned, it does not include capital expenditures, which appear on the balance sheet instead.
How to Calculate Net Income from a Balance Sheet
It’s easy to know how to calculate net income from a balance sheet. Actually, you need two consecutive balances sheets. Simply, you subtract the earlier balance sheet’s equity from that of the later sheet. For example, if the earlier equity is $500K and the later equity is $600K, the net income for the period is ($600K – $500K), or $100K. You must adjust this if the owner draws dividends, changes the capital structure or makes capital expenditures. It’s useful to know how to calculate net income from a balance sheet. However, the only reason to do it is to verify the income statement.
As an illustration, imagine you own an apartment building that could earn $40,000 a month in rent. In this case, let’s say it’s 95% occupied, and costing you $2,000 in potential rental loss. Furthermore, all tenants are up-to-date on their rents. Additionally, you earn fees of $500 a month. Consequently, your total monthly income is ($40,000 – $2,000 + $500), or $38,500. Further, your operating expenses for the month total $28,000. Accordingly, this gives you an NOI of ($38,500 – $28,000), or $10,500. Your non-operating expenses are $3,000 for the month. Consequently, your net income is ($10,500 -$3,000), or $7,500.
Net Income FAQs
1) How do I calculate net income investment tax?
This is a 3.8% surtax on your modified adjusted gross income (MAGI) or net investment income (NII). Next, to calculate, subtract $200,000 ($250,000 for joint filers) from your MAGI and from your NII. Then, multiply the smaller positive number (if any) by 3.8% to obtain the tax amount
2) How do I calculate annual incremental NOI?
You calculate annual incremental NOI as net operating assets minus net operating expenses for the year. Naturally, it excludes the items not found in NOI, such as income tax and interest expense. Consequently, the result reports the net value of operating assets after you account for net operating expenses.
3) How do I calculate monthly net income and NOI?
It’s easy to calculate net income and NOI. First, you calculate NOI as total revenues minus operational expenses. Subsequently, the net income formula is total revenues minus all expenses, adjusted for gains, losses and extraordinary items. Finally, net income is synonymous with profit, net earnings, and the bottom line.
4) What’s the difference between net income and net operating income?
The difference between net income and NOI is the expenses you include with each. Moreover, NOI includes only the expenses directly related to the running of your properties. Net income includes all expenses, plus capital gains/losses and extraordinary items. A positive NOI and negative NI indicates non-operational problems with the business, such as financing.
5) What is a balance sheet?
The balance sheet is a primary financial report detailing a company’s assets, liabilities and equity. It is a snapshot in time of the state of your business. Furthermore, you can compare two successive balance sheets to derive the net income for the period. However, to do so, you must adjust for changes to the capital structure, owner drawings/dividends, and capital expenditures.