| Line item | Amount |
|---|---|
| Gross potential rent + other income | 63,000 dollars |
| Less vacancy and credit loss (5 percent) | minus 3,150 dollars |
| Effective gross income | 59,850 dollars |
| Less operating expenses | minus 22,000 dollars |
| Net operating income (NOI) | 37,850 dollars |
Glossary · Investment
Net Operating Income (NOI)
Net operating income, or NOI, is a rental property's total operating income minus its operating expenses, calculated before mortgage payments, income taxes, and major capital expenditures. It measures how the property itself performs, independent of financing, and feeds directly into the cap rate. A realistic vacancy allowance is subtracted so the figure reflects likely collected income.
Also known as: NOI
How is net operating income calculated?
NOI equals effective gross income minus operating expenses. Start with gross potential rent plus other income, subtract a vacancy and credit allowance to get effective gross income, then subtract operating costs such as taxes, insurance, management, maintenance, and utilities.
Operating expenses are the recurring costs of running the property. They include property taxes, insurance, property management, repairs and maintenance, utilities the owner pays, landscaping, and reserves for routine upkeep.
Deliberately left out are the mortgage payment, income taxes, depreciation, and large capital expenditures like a new roof. Excluding these keeps NOI focused on operations rather than on one owner's loan or tax situation.
Why does net operating income matter?
NOI is the foundation of income-property valuation. It drives the cap rate, supports loan underwriting through the debt service coverage ratio, and lets investors compare properties on operating performance alone, before financing choices distort the picture.
Lenders divide NOI by annual debt service to compute the debt service coverage ratio, a key test for approving loans. Appraisers divide NOI by a market cap rate to estimate value.
Because small changes in income or expenses move NOI, and NOI moves value, raising rents or trimming costs can meaningfully increase what a property is worth. This is the core idea behind value-add investing.
What is the difference between NOI and cash flow?
NOI stops before the mortgage; cash flow continues past it. NOI equals income minus operating expenses only. Cash flow subtracts debt service and often reserves from NOI, showing the money an owner actually keeps after paying the loan.
Two investors buying the same property have identical NOI but different cash flow, because each finances the purchase differently. NOI describes the asset; cash flow describes the deal.
NOI also excludes capital expenditures, so a property with strong NOI can still strain cash if a roof or HVAC system needs replacing. Track reserves separately to avoid surprises.
Worked example. For example, suppose a duplex earns 60,000 dollars in gross potential rent plus 3,000 dollars from laundry and parking, for 63,000 dollars of gross income. You apply a 5 percent vacancy allowance, about 3,150 dollars, leaving 59,850 dollars of effective gross income. Operating expenses run 22,000 dollars, covering property taxes, insurance, management, and maintenance. NOI equals 59,850 minus 22,000, or 37,850 dollars per year. Note the mortgage is not subtracted.
Common mistakes with Net Operating Income
- Do not subtract the mortgage principal or interest from NOI, because debt service belongs to cash flow, not operating income.
- Do not forget the vacancy and credit allowance, since assuming full occupancy inflates NOI and overstates value.
- Avoid excluding real operating costs such as management or reserves just to make a property look more profitable.
- Do not include capital expenditures like a new roof in operating expenses, as these are treated separately from NOI.
- Do not confuse a seller's optimistic pro forma NOI with the property's actual, verified operating history.
Related terms
Term
Capitalization Rate (Cap Rate)
A property's net operating income divided by its value, used to gauge investment return an
Define TermCash Flow
The money left over from a rental property after all expenses, including the mortgage, are
Define TermCash-on-Cash Return
The annual pre-tax cash flow of an investment divided by the actual cash invested.
Define TermGross Rent Multiplier (GRM)
A property's price divided by its gross annual rental income, used as a quick screening ra
DefineNet Operating Income FAQ
Does NOI include the mortgage payment?
No. NOI is calculated before any debt service, meaning mortgage principal and interest are excluded. This keeps NOI focused on the property's operating performance so it can be compared across buildings regardless of how each owner finances the purchase.
Is NOI calculated before or after taxes?
NOI is figured before income taxes and before depreciation. It does include property taxes, which are an operating expense, but not the owner's federal or state income tax. This distinction keeps NOI tied to operations rather than an individual's tax position.
How does NOI relate to cap rate?
Cap rate equals NOI divided by property value. NOI is the numerator, so an accurate NOI is essential to a meaningful cap rate. Rearranged, value equals NOI divided by the market cap rate, which is how income properties are commonly priced.
Are capital expenditures part of NOI?
No. Large one-time costs such as replacing a roof, HVAC system, or parking lot are capital expenditures, not operating expenses, so they are excluded from NOI. Many investors still set aside reserves for them and track that separately from the NOI calculation.
Can NOI be negative?
Yes. If operating expenses and vacancy exceed the property's income, NOI is negative, signaling the property loses money at the operating level before any mortgage. Negative NOI is a warning sign, often seen with high vacancy, deferred maintenance, or mismanagement.
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