Glossary
What is net operating income (NOI) in real estate?
Quick answer
Net operating income (NOI) is a property's income after operating expenses and before debt payments, capital improvements, depreciation, and income taxes. The formula is effective gross income minus operating expenses. For example, a 24-unit building with $397,440 of effective gross income and $153,346 of operating expenses has an NOI of $244,094 per year.
Net operating income (NOI) is the income a property produces from operations. It equals all operating income minus all operating expenses. It leaves out financing, capital spending, and taxes on the owner's income.
How NOI works
The calculation has three steps:
Start with gross potential rent: every unit at full rent for the year.
Subtract vacancy and credit loss. Add other income, such as parking and laundry. The result is effective gross income (EGI).
Subtract operating expenses: property taxes, insurance, repairs and maintenance, utilities, payroll, and management fees.
These items are not operating expenses, so they stay out of NOI:
Debt service. Mortgage principal and interest depend on the owner's financing, not on the property.
Capital improvements. IRS Publication 527 says you must capitalize any expense you pay to improve rental property. Those costs are generally depreciated, not deducted. See capital expenditure.
Depreciation and income taxes.
Example: a 24-unit building for one year
Line | Amount |
|---|---|
Gross potential rent (24 x $1,400 x 12) | $403,200 |
Less vacancy and credit loss (5%) | -$20,160 |
Plus other income (parking, laundry) | +$14,400 |
Effective gross income | $397,440 |
Property taxes | $52,000 |
Insurance | $18,500 |
Repairs and maintenance | $31,200 |
Utilities | $27,800 |
Management fee (6% of EGI, rounded) | $23,846 |
Total operating expenses | $153,346 |
Net operating income | $244,094 |
EGI is $403,200 - $20,160 + $14,400 = $397,440. Operating expenses add to $153,346. NOI is $397,440 - $153,346 = $244,094.
The owner also paid $160,000 of mortgage payments and $45,000 for a roof replacement. Neither changes NOI. They do change cash flow: $244,094 - $160,000 - $45,000 = $39,094.
Investors often value a property by dividing NOI by a capitalization rate. At a 6% cap rate, this building's value is about $244,094 / 0.06 = $4,068,233. That is why one miscoded expense matters. Every $1,000 of NOI is worth about $16,667 at a 6% cap rate.
Related terms
Gross potential rent
Vacancy rate
Economic occupancy
Capital expenditure
Where software helps
NOI is only as accurate as the expense coding in the general ledger. Software that separates repairs from capital work and runs NOI reports by property makes the number reliable. Darcy's accounting module includes a general ledger and 112 reports from the ledger, and Darcy also covers investment entities. See software for real estate investment entities, or book a demo.
Questions, answered
Does NOI include mortgage payments?
No. NOI is calculated before debt service, so two identical buildings with different loans have the same NOI. Cash flow after debt service is a separate measure.
What is the difference between NOI and cash flow?
NOI is income minus operating expenses. Cash flow subtracts debt payments and capital spending from NOI. A property can have strong NOI and weak cash flow if its loan payments or capital projects are large.
How do you increase NOI?
Raise income or lower operating expenses. Common methods are lower vacancy, less loss to lease, fewer bad debts, and lower repair costs through preventive maintenance.
Sources and method
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