In order to evaluate rental property for sale, investors need to use certain real estate metrics. For a real estate investment analysis to be accurate or effective, it’s best to look at multiple metrics. Two of the most fundamental metrics are net operating income (NOI) and cash flow. But what is NOI? What about cash flow? How do you calculate these metrics? Which metric is better for a rental property analysis? How can you quickly calculate NOI and cash flow? In this blog about NOI vs cash flow, we’ll answer all of these questions!
What Is NOI?
Let’s start discussing NOI vs cash flow with the simpler of the two metrics: net operating income. Net operating income is the amount of annual profit earned by a property. It is the difference between all the real estate revenue and operating expenses of an investment property. NOI allows real estate investors to understand the financial performance and profitability of a property based on its required costs. Since its main variables are not static, NOI can change over time. Regardless, the metric tells real estate investors if their properties generate enough rental income to pay off debt service. As a result, NOI is one of the most important metrics in real estate investing.
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How to Calculate NOI
Understanding how to calculate NOI can be a bit complicated, due to the many factors involved. Nonetheless, knowing how the net operating income formula works will help you better comprehend the concept. It will also improve your understanding of cash flow and NOI vs cash flow, as both are fairly similar. As mentioned earlier, NOI depends on two main factors: rental revenue and operating expenses. Here is what the net operating income formula looks like:
NOI = Real Estate Revenue – Total Operating Expenses
Calculating NOI would be a walk in the park if it only depended on these two variables. The reality is, however, that each variable breaks down into many other factors. Real estate revenue, for instance, is the sum of rental income and other income possibly coming from parking spaces or the like.
Related: Real Estate Investing 101: How to Calculate Rental Income
Total operating expenses is the second variable used for calculating NOI. These include all expenses necessary to maintain and operate a rental property. Mortgage payments, depreciation, amortization, and capital expenditures, however, are not included as operating expenses in the NOI formula. As you will see later, these expenses are key to understanding NOI vs cash flow.
Here are some of the most common operating expenses:
- Vacancy
- Property Taxes
- Insurance
- Repairs and Maintenance
- Property Management Fees
- Utilities
- Advertising
What Is Cash Flow?
Cash flow is the difference between the rental revenue and rental expenses of an investment property. Cash flow tells real estate investors if their investment properties are profitable and how much money is being made. When asking how much cash flow is good for rental property, the goal is to have a positive cash flow. Positive cash flow properties, or positively geared properties, earn more in income than they cost in rental expenses. A negative cash flow property, on the other hand, costs more in expenses than the revenue can cover.
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How to Calculate Cash Flow
Learning how to calculate cash flow is very straightforward. The cash flow formula is:
Cash Flow = Total Rental Revenue – Total Rental Property Expenses
Look familiar? While rental revenue remains the same for both NOI vs cash flow, the expenses actually differ. Rental property expenses are quite similar to the operating expenses in the NOI formula. The main difference, however, is that rental expenses include income taxes, mortgage payments, depreciation, and amortization. Common examples of rental property expenses used to calculate the cash flow include:
- Property taxes
- Rental income tax
- Property insurance
- Utilities
- Advertising
- Mortgage interest and principal payments
- Property management costs
- Vacancy costs
- Repairs and maintenance
- HOA dues (for condo investments)
- Cleaning fees (for Airbnb rental properties)
Related: A Comprehensive List of Rental Property Expenses for Investors
NOI vs Cash Flow
We now reach the focal point of the blog – NOI vs cash flow. Is net operating income the same as cash flow? If you followed along, you might have noticed that we basically answered the question earlier. When it comes to expenses, NOI solely relies on expenses related to the rental property. The expenses used to calculate cash flow include those related to both the rental property and real estate investor. In the end, you need to calculate NOI to find rental property cash flow. You can even rewrite the cash flow formula to illustrate this:
Cash Flow = Total Rental Revenue – Total Rental Property Expenses
Since the total rental property expenses equals the sum of operating expenses and debt service, depreciation, income tax, and others:
Cash Flow = Total Rental Revenue – (Total Operating Expenses + Debt Service, Depreciation, Income Tax, etc.)
By distributing the negative sign:
Cash Flow = Total Rental Revenue – Total Operating Expenses – Debt Service, Depreciation, Income Tax, etc.
Since the difference between total rental revenue and total operating expenses is the same as NOI:
Cash Flow = Net Operating Income – Debt Service, Depreciation, Income Tax, etc.
Clearly, the difference between NOI vs cash flow is not as wide as it may have appeared. At the end of the day, both real estate metrics are required for a complete investment property analysis.
How to Quickly Calculate NOI and Cash Flow
Speaking of a real estate analysis, how can you calculate net operating income vs cash flow quickly? While both metrics use relatively simple math, a real estate investment tool is required to quickly, effectively, and accurately acquire the necessary data and complete the calculations. Fortunately, that tool does exist, and its called Mashvisor’s investment property calculator.
Mashvisor’s real estate software provides the necessary calculator to estimate NOI and cash flow. It mostly functions as a cash flow calculator. However, because you can make adjustments to the costs used for analysis, you can easily see what your NOI would be. That way, you can easily decide what is a good NOI or cash flow for any rental property for sale in the US housing market.
CLICK HERE to start your 7-day FREE trial with Mashvisor. For more on NOI vs cash flow, check out Mashvisor’s daily real estate investment blog.
Related: What’s the Best Real Estate App of 2020?