How is net operating income calculated using gross potential rental income?

Net operating income (NOI) is a critical financial metric used in real estate to assess a property's profitability. It is calculated by taking the gross potential rental income and adjusting it for vacancies and credit losses. Gross potential rental income refers to the total income a property would generate if it were fully rented at market rates.

The calculation for NOI subtracts vacancies and credit loss from gross potential rental income because these factors represent potential income that will not be realized. Vacancies account for the units that are not rented, while credit loss reflects income that the landlord does not receive due to tenants failing to pay their rent. By incorporating these considerations, the calculation reflects a more realistic view of the income that the property generates.

In summary, by accurately deducting the vacancies and credit losses from gross potential rental income, one arrives at the net operating income, which provides a clearer picture of a property's financial performance. This understanding is essential for real estate investors and property managers when evaluating the viability and profitability of the property.