- ALTERNATIVE INVESTMENTS
- REAL ESTATE INVESTING
While net operating income (NOI) is for property-related income and expenses, earnings before interest and taxes (EBIT) cover a company’s profitability in any sector, including real estate. NOI is a way to see how profitable a real estate investment is, accounting for what it makes minus the costs of running it. At the same time, earnings before interest and taxes (EBIT) gives a broader picture of a company’s financial health before loan costs and taxes come into play.
KEY TAKEAWAYS
- Calculating net operating income (NOI) involves subtracting operating expenses from a property's revenues.
- Calculating earnings before interest and taxes (EBIT) uses the same equation, but depreciation and amortization are included.
- Income taxes do not affect a company's NOI or EBIT; property taxes are included in both.
- Operating expenses are those necessary to maintain revenue and profitability.
NOI doesn't account for interest, taxes, capital expenditures, depreciation, or amortization expenses. For its part, EBIT consists of revenues minus expenses, apart from taxes and interest, but it does consider depreciation and amortization expenses. In essence, EBIT is a profitability measure for a company that factors in more expenses than NOI.
Net Operating Income (NOI)
NOI is generally used in the real estate market to assess a property's ability to generate income. Real estate can generate revenue from rent, parking, servicing, and maintenance fees. Properties might have operating expenses, including insurance, property management fees, utility expenses, property taxes, janitorial fees, snow removal and other outdoor maintenance costs, and supplies.
The standard way to categorize an operating expense is to look for those directly related to a company's core operations. Thus, since interest is related to financing and income taxes are not core operations, they are not part of the NOI, which is calculated as follows:
Gross revenue - operating expenses = NOI
NOI also determines a property's capitalization rate or rate of return. A property's capitalization is calculated by dividing its annual NOI by its potential selling price.
Earnings Before Interest and Taxes (EBIT)
EBIT is calculated by subtracting a company's cost of goods sold (COGS) and its operating expenses from its revenue. EBIT can also be computed as operating revenue plus nonoperating income minus operating expenses.
Let's use an example. During the last fiscal year, Company ABC recorded its revenue as $50 million, nonoperating income as $1 million, COGS as $20 million, depreciation expenses as $3 million, and maintenance as $10 million. The EBIT is calculated as follows:
$50 million + $1 million - $20 million - $3 million - $10 million = $18 million
NOI vs. EBIT Example
Assume an investor buys an apartment building in an all-cash deal. The property generates $20 million dollars in rent and service fees. The apartment building has operating expenses of $5 million and depreciation expenses from its laundry machines of $100,000.
The resulting NOI generated by the apartment building would be $15 million: $20 million less $5 million. This is because depreciation is not included.
The building's EBIT would be different since it accounts for the depreciation expense. Therefore, the resulting EBIT generated by the apartment building would be $14.9 million: $20 million minus $5 million minus $100,000.
Are EBIT and NOI part of GAAP?
Generally accepted accounting principles (GAAP) are the accounting rules that public companies in the U.S. must use when creating their financial statements. Neither NOI nor EBIT are GAAP measures, which means companies may but are not required to report them.
How Do Investors Use EBIT?
Investors often use EBIT to compare the performance of companies in the same industry. EBIT measures operating profits while ignoring noncore expenses like interest and taxes. So, companies with a higher EBIT than others in the same sector will likely be financially stronger and more valuable.
How Do Investors Use NOI?
NOI gives investors a way to measure the cash flow of a company or property. The higher a property's NOI, the more cash an investor can expect to receive from the investment. Thus, you can compare the NOI of investment properties to determine which produces a stronger cash flow.
Are NOI and EBIT Always Different?
The methods used to calculate NOI and EBIT differ, but in some cases, NOI and EBIT may be the same. For example, if the apartment building in this article's example didn't have depreciation expenses, its EBIT and NOI would match.
The Bottom Line
NOI and EBIT are both measures used to determine the profitability of a company or real estate investment, but each accounts for different expenses. NOI measures an entity's ability to produce income, while EBIT measures the entity's ability to make a profit after expenses. Investors can use both metrics to determine a company or a property's value.