Cody explains Net Operating Income (NOI), the cash flow left after all operating expenses are deducted from gross revenue. A property worth $1 million at a 6% cap rate generates $60,000 annual NOI. Increasing NOI through higher rents or lower costs directly raises the property's value.
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Hey, YouTube. This is Cody. And today's video, we're starting the new playlist in my channel called Mastering the Real Estate Math. Now, the objective of these videos is to keep it short, sweet, and simple on exactly what you need to know. I'm not going to be adding anything you don't need to know because the math in real estate is super simple. Some people overcomplicate this. When you understand the, the main metrics and the key terms you need to know when you're looking at a deal, you can go quickly and you're not going to miss as many opportunities. So that said, today's video is about NOI. This is likely the most important term that you need to master and get good at underwriting for. And NOI is what we call net operating income. If you can figure this one piece out, you will never overpay for a piece of real estate., you'll be able to underwrite what you can get it to perform at in the future. And we're not going to talk any percentages today. We are just going to talk about the terms and we will build out the underwriting in the future. That said, net operating income is the income, the actual cash flow you would get if you owned a property outright. Now you have property expenses when you own real estate. You've got property taxes, you've got insurance, You've got maintenance, management, utilities. You're not going to be 100% full all the time, so you got to budget for vacancy. With all that said, if you own a piece of property outright, how much would you actually get to keep? That is our net income, and that is how we value commercial real estate. That's how we value apartment buildings. People who buy apartments, buy commercial real estate, they're not the average home buyer. They could be, but they're not. And so what we got to look at is who's our buyer pool? It's going to be an investor, someone who's looking to get a return. And again, I mentioned that I'm not going to be talking percentages today. I'm not diving deep into that. But if we think very high level right now, we're looking at, okay, we have an investor who would buy it and it makes a certain amount of money every year. It's going to be net income. So they're going to be looking for X return. Now, every market's different. There's no such thing as one real estate market. But they're going to want a certain percentage return. I look for 6% if I were paying cash and I leverage. But if I paid cash, I want 6%. And so I take that net income, I divide it by my 6%, and that comes up with my value. If I can raise my NOI, if I can raise my net income, maybe that comes from raising rents, maybe that comes from decreasing expenses or both, then my values go up because it'll make more money for the next investor., and then they can afford to pay more and still make their target return. And so that is the main premise of why understanding your NOI and how to improve it, your net operating income, is so important. Because if you can increase the amount of money that you make every month, you make every year, you're going to be able to sell it or refinance it with the next bank or the next buyer at a much higher value than you bought it for, and you're going to learn that you're not going to overpay for something because you cap out your top offer. And then I don't want to overcomplicate this, but if you have a property that nets $60,000 a year and you want to make a 6% return, you can pay $1 million cash and you will make your 6% return. If that's all you take away from this, you're able to Understand where you can pay without overpaying and still hitting your targets. Some markets are going to be 8%, some markets are going to be 4%. Depends where you're investing. But that said, that is the high-level overview of net operating income. You will always analyze for net income, your NOI, on an annual basis. You're never going to do it on a monthly basis. And to wrap up today's video, Let me know in the comments below if you have any more questions on this. I'm going to try and keep this section short. The math is super simple. Today it was just about the terms, but we're going to go into deep dive analysis, actual property details in the future, and that will sum this section up. Till next time, have a great week, and I'll see you guys on Friday.
