Net operating income
Sector Deep DivesRent collected less the property costs a landlord bears and cannot recharge, the income figure every real estate yield is built on.
Also written: NOI, net rental income
Net operating income is the top of the real estate stack. It is gross rent less the costs of owning and running the building that the landlord cannot pass to tenants: management, insurance, non recoverable service charge, and the rates and running costs of empty space. It sits before interest, before tax, before depreciation and before any corporate overhead.
Everything else in the sector divides by it or into it. A cap rate is NOI over value. A yield on cost is stabilised NOI over development cost. A debt yield is NOI over the loan. Get NOI wrong and every one of those numbers is wrong in the same direction.
Two things distort it in practice. The first is voids, because empty space costs money rather than being merely neutral. The second is the difference between passing rent, which is what tenants pay today, and market rent, which is what the space would let for now. A building let below market has a NOI that understates its economics, and a building let above market has one that overstates them.
It is also the line that makes the difference between accounting rent and cash rent visible. Under IFRS, rent free periods and contracted uplifts are spread across the lease term, so reported rental income can run ahead of cash collected for years after a big letting.
Worked example
A building lets for 6.0 of gross rent. Management and insurance take 0.4, the service charge on two empty floors costs 0.3, and 0.3 of rates and running costs on that empty space fall to the landlord.
Net operating income is 6.0 less 1.0, so 5.0. At a 5.0% cap rate that supports a value of 100.
Let the empty floors and the same building produces more NOI on two counts: the new rent arrives and the 0.6 of empty space cost disappears.