Net Operating Income (NOI) in Real Estate: Definition and Calculation

Net operating income, or NOI, is what a rental property earns in a year after an allowance for vacancy and the costs of running it, but before mortgage payments, depreciation and income tax. It is the number cap rates, appraisers and lenders all start from, and the one a seller is most tempted to dress up.

The formula

Line	What goes in
Gross scheduled rent	Every unit’s rent for 12 months, as if always full
+ Other income	Parking, laundry, storage, pet rent
− Vacancy and credit loss	Empty months, and rent never collected
= Effective gross income	What the property really takes in
− Operating expenses	Tax, insurance, repairs, management, owner-paid utilities
= Net operating income	What the property earns before financing

In one line: NOI = effective gross income − operating expenses. The glossary entry on NOI has the short definition.

A duplex, line by line

A duplex rents each side for $1,500 a month: $36,000 a year in scheduled rent. A garage rented to a neighbor adds $600 a year.

Vacancy. Allow 5% of the rent: $1,800. Effective gross income is $36,000 + $600 − $1,800 = $34,800.

Operating expenses. Property tax $5,100, insurance $1,700, repairs $2,600, management at 8% of effective income $2,784, water and sewer $1,500, and lawn care and snow removal $600. Total: $14,284.

NOI = $34,800 − $14,284 = $20,516 a year, or about $1,710 a month.

Expenses here take 41% of effective income. The rough “50% rule” guesses operating costs at half the rent; real bills beat any rule. The NOI calculator lays out the same lines with your own figures, monthly or yearly, and shows the sum step by step.

What counts, and what stays out

In NOI:

• Property tax and insurance.
• Repairs and routine maintenance.
• Management fees, even if you manage it yourself. A buyer will price in a property manager, so you should too.
• Utilities the owner pays, HOA dues, landscaping, snow removal and pest control.
• Advertising, legal and accounting costs for the property.

Not in NOI:

• Mortgage principal and interest. That is financing, and it depends on the buyer, not the building.
• Depreciation. A tax deduction, not money spent.
• Income tax. It depends on the owner.
• Capital improvements. A new roof or furnace is a one-off. Many investors set aside a reserve for them below the NOI line.
• The owner’s personal costs, such as a car or a home office.

The test is simple: NOI describes how the building runs, whoever owns it and however they paid for it. That is why two buyers with different loans can agree on the same NOI.

Where each number comes from

• Rent: the signed leases, not the listing. Twelve months at today’s rents.
• Vacancy: your own history, or the local vacancy rate. An allowance of 5% is about 18 days a year for each unit, and a unit that turns over every year can sit empty for longer.
• Property tax: the current bill, raised to what a reassessment at your purchase price would bring.
• Insurance: a quote for a landlord policy in your name, not the seller’s old premium.
• Repairs: 12 months of invoices, or a set-aside of 5% to 10% of the rent for an older building.
• Management: 8% to 12% of collected rent is a common range for small residential rentals, often with a leasing fee on top.

Use the last 12 months of actual figures for the property as it runs today. Keep any projection of what you plan to change on a separate line, labeled as a projection.

From NOI to value

Buyers price rentals by dividing NOI by a cap rate:

At a $300,000 price, the duplex’s cap rate is $20,516 ÷ $300,000 = 6.84%. If similar duplexes nearby sell at a 7% cap rate, its NOI supports a price of $20,516 ÷ 0.07 = $293,086.

This is why every dollar of NOI matters. At a 7% cap rate, each dollar of yearly NOI is worth about $14.29 of price, so shopping the insurance and saving $300 a year adds about $4,286 of value. The cap rate calculator runs the division either way, and the cap rate guide covers what counts as a good one. A cruder yardstick, the gross rent multiplier, skips expenses entirely, which is exactly why NOI is the better number.

NOI is not cash flow

Cash flow is what is left after the mortgage.

The buyer puts $75,000 down and borrows $225,000 at 6.5% for 30 years. The payment is $1,422.15 a month, or $17,065.80 a year.

Cash flow = $20,516 − $17,065.80 = $3,450.20 a year, about $288 a month. On the $75,000 down payment, that is a 4.6% cash-on-cash return, before closing costs.

An all-cash buyer would keep the full $20,516. Lenders read the same two numbers: NOI divided by the yearly loan payment is the debt service coverage ratio, here 1.20. Many lenders want to see at least 1.2 to 1.25 before they lend on a rental.

Four ways a seller’s NOI runs high

1. No vacancy. Every unit full, every month of every year.
2. No management. The seller manages it and leaves the cost out. You will pay someone, even if it is you.
3. Last year’s tax bill. Many places reassess a property when it sells, and the new owner’s tax bill can be much higher.
4. Pro forma rent. The rents the units could get, not what the rent roll and the signed leases show.

Leave out vacancy and management on the duplex and NOI jumps from $20,516 to $25,100, which turns a 6.84% cap rate into 8.37% on paper. Rebuild NOI from the signed leases, the tax bill, an insurance quote and 12 months of real expenses before you trust a listing’s figure.

Raising NOI

The same lines work in reverse. Raise rents toward market at renewal, cut vacancy with faster turnovers, bill back water and sewer where the law and the lease allow, appeal a tax assessment that looks high, and shop insurance every year. Each one makes the property worth more, not just earn more.