When researching accounting terms related involving real estate businesses, you may come across net operating income. Not to be confused with net income, it’s used extensively by property developers and investors to determine the profitability of a piece of property. Real estate isn’t cheap. Before buying a piece of property for the purpose of generating revenue, developers and investors will often evaluate its net operating income. What is net operating income exactly?
Overview of Net Operating Income
In real estate, net operating income refers to the profitability of a piece of real property. It takes into account the property’s gross operating income and operating expenses.
Buying a piece of property typically comes with expenses. Developers and investors will foot the bill for the expenses, which can eat into their profits. To determine whether a piece of property is worth buying, they’ll calculate its net operating income. Developers and investors will estimate the property’s gross operating income and its operating expenses. Using this data, they’ll identify its net operating income.
How to Calculate Net Operating Income
You can calculate the net operating income for a piece of property by subtracting its gross operating income by its operating expenses. Gross operating income, of course, is the income the property is expected to generate. Operating expenses, on the other hand, include all non-tax costs associated with buying, maintaining and selling or utilizing the property as a commercial investment.
Why Net Operating Income Is Important
Net operating income is important for real estate businesses because it provides insight into whether or not a piece of property is a smart investment. Real estate businesses buy properties to make money. If a piece of property’s expenses outweighs its gross operating income, developers and investors should avoid it. They won’t make money when expenses exceed gross operating income.
Fortunately, net operating income is a calculation that reveals whether a piece of property is worth investing in. It looks at the property’s gross operating income and its operating expenses. Using this simple formula, developers and investors can determine the property’s profitability. They generally want properties with a high net operating income. A high operating income is a sign of profitability in which the underlying property has high gross operating income and low operating expenses.
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