Purchasing a new home for your vacation rental company is a risk. If you make a wise investment that pays off, it has the potential to propel your company to new heights. If your investment fails, you may be left with a mountain of debt and payments from an empty property.
How can you determine whether your investment is worthwhile? There is no way to tell for certain, but there are various real estate investing formulae that may help you calculate how hazardous your investment is. NOI, or net operating income, is one of these formulae.
What exactly is NOI?
The net operating income (NOI) of a property is used to assess if it is a good investment by examining its continuing expenses. You may use this method to obtain a good sense of how much return you can expect from your investment. Then you may assess if the money generated by your vacation rental property is worth the purchase and operating expenditures.
This technique enables you to examine the real estate market as well as specific properties to determine how much money may be made after costs.
NOI is a useful estimating tool for making quick financial choices. However, it is vital to remember that NOI does not take into account capital expenditures, taxes, or interest payments. Because of this exclusion, NOI is less susceptible to manipulation than other investment property computations.
How to Determine NOI
The formula for computing NOI is as follows:
Net operating income is calculated as the difference between gross operating income and operating expenses.
The operational expenditures are subtracted from the gross operating revenue in the calculation. NOI is normally computed every year; however, by dividing costs by 12, the formula may be converted to a monthly basis.
Gross operating profit
Gross operating revenue is the entire rental money earned by renting out your vacation rental property.
One difficulty in projecting gross operating revenue when computing NOI is that it is dependent on how the property is managed. Roadblocks will always emerge, and a vacation rental property will not always be running at its full capacity. Thus, it is critical to examine market considerations and use them as a reference when predicting rental revenue.
The formula for calculating gross operating income is as follows:
Potential Rental Income – Vacancy Rate = Gross Operating Income
Potential rental revenue is the amount you would earn if your short-term rental property was occupied every day of the year. Vacancy rates are the property’s vacancy percentage, or the proportion of days the short-term rental is unoccupied. This may be discovered by utilizing historical data or the vacancy rate of similar properties.
When computing NOI, add any extra revenue from the property to your total operating income. This may include parking lot revenue, vending machine income, coin laundry machine income, or any other money earned by the rental property.
The operating expenditures are the costs of owning and operating the vacation rental investment property. Consider the day-to-day expenses of operating the property, such as:
- Fees for property management
- Maintenance and repair expenses
- Legal expenses
- Taxes on real estate
- Insurance premiums
- Accounting charges
- Marketing expenses
There may be more operational expenditures in addition to those listed above, so be sure you account for each expense for your specific investment property.
Extra Tip: Use vacation rental software that is free.
What isn’t covered by the NOI?
Some expenses are eliminated from your NOI calculations because they are incompatible with the goal of net operating income, which is to provide insight into the cash flow of a rental property. It is critical to distinguish between property expenditures, which are included, and investor-specific charges, which are not.
Costs to exclude out of your NOI calculations:
- Mortgage interest and payments
- Personal income taxes
- Commissions on leasing
- Debt repayment
- Tenant enhancements
- Capital investments
- One-time wear and tear repairs
Cap Rate and NOI
NOI and Cap Rate are linked investing words in the real estate industry since NOI is used to calculate the Cap Rate of an investment.
Cap Rate is calculated as follows:
Net Operating Income/Purchase Price = Capitalization Rate
While NOI analyses cash flows to assess whether or not a property is a viable investment, Cap Rate is used to determine the prospective profitability of a certain investment or to predict the return on investment for a given property. They are utilized in tandem to help you make a better-educated selection.