# Calculating Stabilized Net Operating Income in Real Estate

Instructor: Eileen Cappelloni

Eileen worked for the Orange County Asssociation of Realtors for 31 years. She has written real estate courses and exams for other publishing companies

This lesson will teach you how to develop an estimate of stabilized net operating income. You will learn what the required information is and the steps necessary to complete the process.

## What Is Net Operating Income?

Net operating income (NOI) is a series of calculations used to determine the feasibility and profitability of income-generating real estate investment properties. It equals all the revenue from the investment property minus all reasonably predetermined and necessary operating expenses. It does not take principal and interest payments, capital expenditures, depreciation, or amortization into consideration.

## What Is Stabilized Net Operating Income?

Let's say you own a commercial piece of property and you normally have a 2% vacancy rate, but last year you did some remodeling, so while you were having the work done on the property, much of your space became temporarily unusable. If you want to determine what the net operating income was on the property last year, your figures would be considerably lower than what they would normally be.

In a case like this, unusually low occupancy can be viewed as temporary, which means stabilized net operating income will provide a more accurate appraisal. Stabilized net operating income is the anticipated income minus expenses that are subject to change and have been adjusted to indicate normally stabilized operations of your commercial property.

## Types of Operating Expenses:

When the following three items are added together, they constitute your total operating expense.

• Fixed expenses: Expenses that do not take occupancy levels into account. Examples include property taxes, property insurance, etc.
• Variable expenses: Expenses that change with occupancy levels. Examples include maintenance charges, utilities, trash removal, property management fees, etc.
• Reserves for replacement: Funds allocated to replace items with a relatively short life span. Examples include appliances, carpets, painting, minor repairs, and other components that wear out and must be replaced from time to time.

## Calculating Stabilized Net Operating Income

You need to take the following steps to estimate net operating expenses. The first three steps result in effective gross income.

1. Estimate the potential gross income for the coming year. This includes contract rent, which is the rent amount as stated in the lease, and market rent, which is based on comparable rents in the area for comparable space.
2. Subtract vacancy and collection losses, which is generally estimated based on the history of the subject property or competitive properties in the same area.
3. Add any other income from miscellaneous sources, such as parking space rentals, vending machines, etc.
4. Subtract operating expenses.

Putting all of these steps together, the formula for arriving at stabilized net operating income (NOI) is:

Stabilized NOI = (PGI - VLC + OI) -OE

Where PGI is Potential Gross Income, VLC is Vacancy and Loss Collection, OI is Other Income, and OE is Operating Expenses.

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