As a residential buyer, you won't usually hear about these terms, but if you are an investor or a commercial real estate buyer or seller, these are very important terms to help you value a property. These terms require a lot of study, but here is a primer:
For all of these examples, let's use a scenario where Bob is buying an investment property being sold by Amy. There is a tenant in the property who is paying $5,000 per month. Amy wants to sell the property for $600,000.
Net Operating Income (NOI):
Here is a description of NOI - "Net Operating Income or NOI is equal to a property's yearly gross income less operating expenses. Gross income includes both rental income and other income such as parking fees, laundry and vending receipts, etc. All income associated with a property. Operating expenses are costs incurred during the operation and maintenance of a property. They include repairs and maintenance, insurance, management fees, utilities, supplies, property taxes, etc. The following are not operating expenses: principal and interest, capital expenditures, depreciation, income taxes, and amortization of loan points." Here's what it means:
Amy's NOI is calculated as follows: $5,000 per month in rent x 12 months = $60,000 in potential rental income (PRI) per year. Then, you deduct her operating expenses - let's say those are $3,000 per year. Therefore her NOI is $57,000 per year.
(It's important to realize that NOI does not include mortgage payments!)
Here is a description of the Cap Rate - " The Capitalization Rate (or "cap rate") is a measure of the ratio between the cash flow produced by an asset (usually real estate) and its capital cost (the original price paid to own the asset) or alternatively its current market value." Here's what it means:
Amy's Cap Rate is $60,000 (her annual cash flow) / $600,000 (her sales price) = 10% (usually referred to as a "10 cap").
You can value a property by taking the cap rate, and dividing it by the NOI. So in this example, the NOI is $57,000 / .1 = $570,000. You can use that to compare against her $600,000 asking price.