What is earnings before interest, taxes, depreciation, and amortization (EBITDA)?
Meanwhile, earnings before interest, taxes, depreciation, and amortization (EBITDA) is also a measure of profitability. Except this time, rather than being a metric that specifically looks at the profit generated by a real estate investment, EBITDA is looked at as a measure of a company's profit. Like NOI, EBITDA is essentially a measure of net income with interest, taxes, depreciation, and amortization added back into the equation.
The formula for EBITDA is as follows
EBITDA = Net Income + Interest + Taxes + Depreciation + Amortization
In this case, similarly to NOI, net income can be found by doing the following calculation:
Net income = Revenue - Cost of Goods Sold - Expenses
In the case of a business, rather than rental income, revenue might be generated from sales, and rather than maintenance costs, your expenses might include any administrative expense generated by your operations.
Notably, EBITDA can also be expressed as:
Operating profit + Depreciation + Amortization
What's the difference between NOI and EBITDA?
When looked at broken down to that level, it's easy to see how NOI and EBITDA are essentially measuring the same things. The biggest difference between NOI and EBITDA is when you would use each calculation and what revenues and expenses are included in the calculation.
NOI in particular is used to evaluate the profitability of a real estate venture while EBITDA is used to measure the profitability of a company.
However, in most cases, these two calculations can be used interchangeably, depending on the context of what is being calculated. Take the debt service coverage ratio (DSCR) as an example. If you were to look at the debt service coverage ratio of a property, the formula would be:
DSCR = Net Operating Income (NOI) / Total Debt Service
However, if you were calculating DSCR for a business, you would use the following calculation instead:
DSCR = EBITDA / Total Debt Service
By using each metric in the appropriate context, you're giving yourself the ability to properly account for the various expenses that go into keeping a property up and running versus a company. In both cases, though, by excluding factors like taxes and interest, which can vary greatly, these calculations make it easier to assess how well the particular asset has the potential to perform in comparison to its competition.
Calculating NOI and EBITDA: Real-World Examples
Even though NOI and EBITDA both measure the profitability of an asset, their calculations look different from one another due to the fact that their income generation processes and expenses are unique to each asset. With that in mind, we've laid out two sample calculations below so you can take a closer look at how each one might function in a real-world scenario.
Let's say a commercial building has a total rental income potential of $8 million per year. Plus a potential parking income of $1 million in the same time frame and a vacancy allowance of $500,000. Meanwhile, it's total operating expenses would amount to $5,500,000. In that case, the NOI equation might look like the following:
NOI = ($8,000,000 + $1,000,000 - $500,000) - $5,500,000
NOI = $8,500,000 - $5,500,000
NOI = $3,000,000
Now, let's say that when a realty company released its financial statements, it showed that the company had a net profit of $2 million in the third quarter. The company paid $25,000 in interest expense and $15,000 in taxes. It's depreciation costs were $100,000 and amortization costs were $40,000. In that case, the EBITDA calculation would be as follows:
EBITDA = $2,000,000 + $25,000 + $15,000 + $100,000 + $40,000
The bottom line
At the end of the day, net operating income (NOI) and Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) are both measures of profitability. However, they measure the profitability of different assets. For its part, NOI is used to calculate the profitability of potential rental properties while EBITDA is used to calculate the profitability of various companies.
Use this post as a guide to the differences between the two calculations as well as how to go about calculating them. Armed with this knowledge, you should be able to calculate the profitability of either of these assets with relative ease.