As you build a real estate portfolio, it is important to understand the numbers behind your potential success. One of those critical numbers is determined by the operating income formula. With a clear picture of your operating income, you can evaluate the profitability of your rental property. 

Want to learn more about this formula? Let’s take a closer look below. 

What is the operating income formula?

The operating income formula will help you determine the operating income of a business. Essentially, the operating income formula illuminates the profits gained from the operations of the business. It also accounts for any expenses that are associated with running the business.

Here’s what the formula looks like:

Operating income = gross income – operating expenses

The gross income is all of the income that the business pulls in. For example, you may own a residential rental property with four units that bring in rental income from four tenants. But additional income streams for the property might include coin laundry machines and vending machines. 

The operating expenses include any costs associated with running the business. Although obvious costs might include unexpected repairs and regular maintenance, there are other hidden costs that need to be considered. A few include depreciation, property taxes, and insurance costs. 

It is important to note that the operating income formula is only as accurate as the numbers you plug into the equation. You may be tempted to rush through the calculations, but taking the time to accurately determine the gross income and operating expenses will lead to a reliable estimation of your operating income. 

In the case of real estate investing, you can use the operating income formula to determine the profitability of a rental property. But this formula can be used across businesses of all kinds. 

What is the formula for net operating income?

The net operating income formula is the exact same thing as the operating income formula. Although the terminology is slightly different, both formulas lead to the same conclusion. You’ll be able to determine the profitability of a business with either formula. 

The net operating income formula is the company income minus any operating expenses. You’ll need the net operating income when determining other real estate metrics, such as the cap rate of a property

Here’s what the formula looks like:

Net operating income (NOI) = gross income – operating expenses

As with the operating income formula, the net operating income formula is only as accurate as the numbers you plug into the equation. Take the time to include accurate numbers for gross income and operating expenses to determine an accurate NOI. 

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Why is the operating income formula important? 

So why does the operating income formula matter? It can help you, or an outside investor, determine the overall health of your business. With a clear picture of your total revenue compared to your operating revenue, you can easily discern the profitability of a company. 

As a real estate investor, understanding your operating income for a property or portfolio can help you understand the current profits of your portfolio. With the information available, you can make strategic decisions as you continue to build your investments. 

If you are seeking financing opportunities to continue building your portfolio, then a potential lender will likely ask for your operating income. A portfolio with a higher operating income is more likely to repay its debts. With that, a lender is likely to view your financing application for a new property more favorably with a higher operating income. 

Now that you have a better understanding of why the operating income of your portfolio is important, let’s explore how to calculate it. 

How do you calculate operating income

Let's learn how to calculate operating income based on the operating income formula. Here’s what the formula looks like: Operating income = gross income – operating expenses. 

Remember, these steps can be used to determine the operating income or the net operating income. 

Calculate gross income

The first step is to calculate the gross income of the property. If you are running this calculation for a rental property, then you’ll start by determining the property’s rental income. Additionally, you should factor in other income streams that the property is producing. 

The sum of all income-producing activity on the property will lead to the gross income. 

Determine operating expenses

Next, you’ll need to determine the operating expenses of the property. In order to do this, you’ll need to add up all of the expenses required to run the business, or property, efficiently. These expenses will include general and administrative costs associated with running the business. 

The sum of all expenses required to run the property will lead to the operating expenses.

Subtract to find the operating income

Finally, you can subtract the operating expenses from the gross income to determine the operating income of the business or property. 

The final result will be as accurate as the numbers you determine for gross income and operating expenses. With that, it is important to take the time to accurately determine the gross income and operating expense before attempting this step. 

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Example of operating income calculation

Here are two examples of the operating income formula in action to help you gain a better understanding. 

Example 1

You own a rental property with five units. Each unit rents for $2,000 per month and all are currently rented. In addition to rental income, you have a coin laundry machine for tenants, which brings in $100 per month. With that, you determine that the gross income of the property for the year is $121,200. 

Next, you look at the expenses of the property. You have a monthly mortgage payment of $2,000 per month, which includes taxes and insurance. Additionally, you pay $250 in utilities for the property each month. With that, you determine that the operating expenses of the property amount to $27,000.

Finally, you subtract the operating expenses from the gross income. This leads to an operating income of $94,200 for the property. 

Example 2

You own a single-family home as a rental property. The home rents for $4,000 per month. You have no other income streams at this property. With that, you determine that the gross income of the property for the year is $48,000.

Next, you look at the expenses of the property. You have a monthly mortgage payment of $1,000 per month, which includes taxes and insurance. The maintenance of the property for the year included landscaping and a replacement refrigerator.  You have no other expenses for the property because the tenant covers the utilities. With that, you determine that the operating expenses of the property amount to $15,000.

Finally, you subtract the operating expenses from the gross income. This leads to an operating income of $33,000 for the property. 

The bottom line

The operating income formula can be a useful way to assess the health of your real estate portfolio. As you continue to build your real estate portfolio, take some time to learn the important real estate terms that can help you approach your investments strategically.