What is NOI? Net operating income explained

The formula

Collected income starts with gross potential rent, the rent you would get if every unit were full all year. Subtract an allowance for vacancy and unpaid rent. Add any other income the property earns, such as laundry, parking or storage fees. The result is often called effective gross income.

Then subtract the costs of running the property for the year. What is left is NOI. It is a yearly number, though you can divide by 12 to see it monthly.

The key idea: NOI describes the property, not the owner. Two buyers with different loans would see the same NOI on the same building. That is why lenders and appraisers like it.

What counts as an operating expense

Operating expenses are the costs to keep the property running and rented:

• Property tax and insurance
• Repairs and routine maintenance
• Property management, often a percent of collected rent
• Utilities the owner pays, such as water, sewer, trash or common-area power
• HOA dues, landscaping, snow removal, pest control
• A reserve for big replacements (CapEx), if you choose to count it here

These are not operating expenses and stay out of NOI:

• Mortgage principal and interest
• Depreciation, which is a tax item, not cash
• Your income tax
• The down payment and closing costs when you buy

CapEx is the one sources disagree on. Many brokers leave it out, which makes NOI look higher. This site's calculators put a CapEx reserve in operating costs. That is more careful, and it is why our NOI can be lower than a listing's. For how to size the reserve, see CapEx reserves for rental properties.

Worked example

Made-up numbers for a duplex, set up the way the rental cash flow calculator works. They are not its starting numbers. Price $300,000. Each unit rents for $1,400 a month.

• Gross potential rent: $1,400 x 2 x 12 = $33,600
• Vacancy and credit loss at 5%: $33,600 x 5% = $1,680
• Collected rent: $33,600 - $1,680 = $31,920

Operating expenses for the year:

• Property tax at 1.2% of price: $300,000 x 1.2% = $3,600
• Insurance: $1,500
• Repairs at 5% of gross rent: $33,600 x 5% = $1,680
• CapEx reserve at 5% of gross rent: $1,680
• Management at 8% of collected rent: $31,920 x 8% = $2,553.60
• Water and trash: $100 a month x 12 = $1,200
• Total: $3,600 + $1,500 + $1,680 + $1,680 + $2,553.60 + $1,200 = $12,213.60

NOI: $31,920 - $12,213.60 = $19,706.40 a year, or about $1,642 a month.

From NOI to the other numbers

Once you have NOI, the rest follow quickly. Keep the same made-up duplex and add a loan of $240,000 at 6% for 30 years. The payment is $1,438.92 a month, or $17,267.04 a year.

• Cap rate: $19,706.40 / $300,000 = 6.57%
• Cash flow: $19,706.40 - $17,267.04 = $2,439.36 a year, about $203 a month
• DSCR: $19,706.40 / $17,267.04 = 1.14

Each one answers a different question. Cap rate compares the property with its price. Cash flow is what is left for you after the loan. DSCR is what a lender checks. Read more in what is a good cap rate and DSCR explained.

Common mistakes

• Using full rent with no vacancy. Even a strong rental has gaps between tenants. See vacancy rate assumptions.
• Leaving out management because you plan to self-manage. Your time has a cost, and a buyer or lender may add it back anyway.
• Using last year's tax bill. A sale can reset the assessed value, so the tax can rise after you buy.
• Putting the mortgage in operating expenses. That mixes two different questions.
• Forgetting repairs because the house looks good today.

Checking a seller's NOI

Listings often show an NOI or a cap rate. Rebuild it yourself before you trust it. Ask for the rent roll, the leases and a year or two of actual expenses. Then compare line by line. If the seller's number has no vacancy, no repairs or no management, add them back. If the rents are above what similar units get, use market rent. The gap between their NOI and yours is often where an overpriced deal hides.

A quick cross-check is the 50% rule, which says operating costs often run near half of gross rent. If a seller's costs are far below that, ask why.

FAQ

Does NOI include the mortgage payment?

No. NOI is measured before the loan. Subtract the mortgage payment from NOI to get cash flow.

Is NOI the same as profit?

No. NOI leaves out the loan, depreciation and income tax. It measures how well the property runs, not what you keep.

Should CapEx reserves be in NOI?

Sources differ. This site's calculators include a CapEx reserve as an operating cost, which gives a more careful NOI. When you compare with a broker's number, ask whether theirs includes it.

Can NOI be negative?

Yes. If operating costs are higher than collected income, NOI is below zero and the property loses money before any loan payment.