Net operating income (NOI) determines an entity's or property's revenue less all necessary operating expenses. NOI does not take into account interest, taxes, capital expenditures, depreciation and amortization expenses. Conversely, earnings before interest and taxes (EBIT) consists of revenues less expenses, excluding tax and interest, but takes into account depreciation and amortization expenses. It determines a company's profitability.
EBIT is calculated by subtracting a company's cost of goods sold (COGS) and operating expenses from its revenue. EBIT can also be calculated as operating revenue and non-operating income less operating expenses.
For example, assume company ABC generated $50 million in revenue, and had COGS of $20 million, depreciation expenses of $3 million, non-operating income of $1 million and maintenance expenses of $10 million during the last fiscal year. Its resulting EBIT for last year was $21 million ($50 million + $1 million - $10 million - $20 million).
NOI is generally used to analyze the real estate market and a house's or building's ability to generate income. Real estate property can generate revenue from rent, parking fees, servicing and maintenance fees. A property may have operating expenses of insurance, property management fees, utility expenses, property taxes and janitorial fees. Income taxes do not impact a company's or real estate investment's NOI. However, property taxes are included in the operating expenses of a real estate investment's operating expenses.
For example, assume an investor purchases an apartment building in an all-cash deal. The property generates $20 million dollars in rents and servicing fees. The apartment building has operating expenses that amounts to $5 million and depreciation expenses of $100,000 for its laundry machines.
The resulting NOI generated by the apartment building is $15 million ($20 million - $5 million). But its EBIT is different. Remember, EBIT takes into account the depreciation expense, so the resulting EBIT generated by the apartment building is $14.9 million ($20 million - $5 million - $100,000).
NOI also determines a property's capitalization rate, or rate of return. A property's capitalization is calculated by dividing its annual NOI by the potential total sale price. Assume our building has a sale price of $120 million. Its capitalization rate is 12.5%.