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What Is Net Operating Income (NOI)?
When it comes to real estate investing NOI or Net Operating Income is calculated by determining the total revenue of the property minus all the necessary operating expenses. This calculation is used to determine the profitability of income-generating real estate investments.
It’s important to note that NOI is a before-tax calculation that shows cash flow. The calculation excludes non-operating expenses such as the principal and interest on mortgage or loan payments, capital expenditures, depreciation, and amortization. In other industries, the closest equivalent is EBITDA (earnings before interest, taxes, depreciation and amortization).
Why is Net Operating Income (NOI) Important?
Net operating income is an essential figure for several different essential real estate metrics and it’s important to understand exactly what it is and how it can be used to determine the current value and potential of an investment property. To calculate NOI, you need to subtract the property’s operating expenses from the total income that the property produces.
Operating expenses include things like ongoing maintenance and operation fees such as property management fees, insurance premiums, legal expenses, or HOA fees. Capital expenditures are not included as they need to be added to the property’s cost basis and depreciated and are not immediately deductible.
In addition to rental income, a property might also produce several other streams of income that need to be included. For example, a property might generate additional revenue from parking, laundry facilities, or vending machines.
NOI can be used to help determine cap rate (capitalization rate), debt coverage ratio (DCR), net income multiplier, and return on investment (ROI). These metrics can help investors understand a property’s value and current performance as well as the potential profitability of a future investment.
What to Include and Exclude From NOI
NOI only counts the income and costs of running the property itself. Anything tied to how you financed it, your personal taxes, or long-term upgrades stays out.
| Include in NOI | Exclude from NOI |
|---|---|
| Rent and other property income (parking, laundry, storage, pet rent, late fees) | Mortgage principal and interest |
| Property taxes | Your income taxes |
| Landlord insurance | Capital expenditures, such as a new roof or HVAC replacement |
| Property management fees | Depreciation and amortization |
| Repairs and maintenance | Security deposits (they belong to the tenant until you keep them) |
| Utilities the landlord pays | |
| HOA fees | |
| Landscaping, snow removal, pest control and trash | |
| Legal, accounting and advertising costs |
Replacement reserves: lenders and appraisers often deduct an allowance for future replacements when they underwrite NOI. Many investors leave it out and track reserves separately. Either is fine, but use the same approach when you compare properties.
How to Calculate Net Operating Income (NOI)
Calculating NOI takes three steps.
Step 1: Work out potential gross income. This is all the rent the property would earn if every unit were let all year at its current rent, plus other income such as parking, laundry and storage.
Step 2: Subtract vacancy and credit losses. Allow for empty months and rent you won't collect, usually as a percentage of potential rent based on your history or local vacancy rates. What's left is your gross operating income (also called effective gross income). There’s more on gross operating income below.
Step 3: Subtract operating expenses. Use the "include" column in the table above. The result is your net operating income.
Net Operating Income (NOI) Formula
Gross operating income = Potential gross income − Vacancy and credit losses
NOI = Gross operating income − Operating expenses
Things that are not included in the calculation of the total operating expenses include:
- mortgage payments (principal and interest),
- income taxes,
- capital expenditures,
- depreciation.
An Example
In this example, we are going to assume the following information as the profile of a particular investment property.
Annual Income Sources:
- Rental income: $20,000
- Parking fees: $5,000
- Laundry machines: $1,000
Potential gross income = $26,000
Less vacancy and credit losses (5% of rental income): −$1,000
Gross operating income = $25,000
Annual Operating Expenses:
- Property management fees: $2,000
- Property taxes: $4,000
- Repair and maintenance: $3,000
- Insurance: $1,000
Total Annual Operating Expenses = $10,000
The net operating income (NOI) in this example would be $25,000 − $10,000 = $15,000.
If the total is negative, where operating expenses are higher than revenues, the result is called a net operating loss (NOL). You can run your own numbers with our free NOI calculator.
From Gross Operating Income to NOI
Gross operating income (GOI) is the income a rental property can realistically expect to collect in a year: its potential gross income minus vacancy and credit losses. It sits between the rent roll and NOI, so any mistake in it carries straight through to your NOI, cap rate and valuation. You’ll also see it called effective gross income (EGI).
Gross operating income = Potential gross income − Vacancy and credit losses
Here’s how the example above moves from potential income to NOI:
| Line | What it means | Example |
|---|---|---|
| Potential gross income (PGI) | All the rent and other income the property would earn if every unit were let all year and every tenant paid | $26,000 |
| Less vacancy and credit losses | Rent lost to empty months and rent you’re owed but never collect | −$1,000 |
| Gross operating income (GOI) | The income you can realistically expect to collect | $25,000 |
| Less operating expenses | Taxes, insurance, management, repairs, utilities and other running costs | −$10,000 |
| Net operating income (NOI) | What the property earns before financing and income tax | $15,000 |
Some investors add other income, such as parking or laundry, after the vacancy deduction instead of in potential gross income. Either approach works, as long as you count each source once and use the same method when you compare properties.
How to estimate vacancy and credit losses
- Vacancy loss is rent lost while units sit empty. Use your own history if you have it, or start from the local vacancy rate. Our vacancy rate calculator can help.
- Credit loss is rent you’re owed but never collect, such as unpaid rent from a tenant who leaves owing money.
- Express both as a percentage of potential gross income. If you’re buying, check the seller’s rent roll and payment history rather than assuming every unit is full and every tenant pays.
What affects gross operating income
- Market conditions: in a strong rental market, units let faster and vacancy is lower.
- Location: properties in sought-after areas usually have fewer empty months.
- Property condition: well-kept homes attract and keep tenants for longer.
- Rent level: rent set well above market means longer vacancies; well below market leaves income on the table.
- Tenant quality: reliable tenants mean fewer missed payments and less credit loss.
How to increase gross operating income
- Price rent at market and review it at each renewal.
- Screen tenants carefully to cut credit losses.
- Shorten turnovers by starting repairs and advertising before the current tenant leaves.
- Add other income, such as parking, storage, laundry or pet rent.
- Collect rent online with automatic reminders so fewer payments go missing.
Why NOI Matters: Valuation and Lending
NOI is the number most other rental metrics are built on.
It sets the property's value. Investors and appraisers value income property by dividing NOI by the local cap rate:
Property value = NOI ÷ cap rate
With an NOI of $15,000 and a market cap rate of 7%, the property is worth about $15,000 ÷ 0.07 = $214,300. Every extra $1,000 of NOI adds about $14,300 of value at that cap rate, which is why cutting costs or adding income has an outsized effect on value. Try it with the cap rate calculator.
It decides how much you can borrow. Lenders compare NOI with the yearly mortgage payments using the debt service coverage ratio (DSCR):
DSCR = NOI ÷ annual debt service
If the mortgage costs $11,000 a year, the DSCR is $15,000 ÷ $11,000 = 1.36. Many lenders look for at least 1.20 to 1.25 on rental properties, and DSCR loans are approved mainly on this number rather than your personal income.
It lets you compare properties fairly. Because NOI leaves out financing, you can compare two properties bought with different loans, or with cash, on equal terms.
Final Words
Net operating income is one of the most commonly used figures that investors and lenders use to determine the potential profitability of a property. For creditors, they rely on this calculation heavily to determine the income generation potential to ensure when assessing the security of a loan, and they often look at this figure more closely than the credit history of the investor.
If a property is deemed by lenders to be a good and profitable investment, the lenders will also use this figure to determine the amount of the loan they’re willing to make. On the other hand, if the property shows a net operating loss, lenders are likely to reject the borrower’s mortgage application, outright.
Property owners can manipulate their operating expenses by deferring certain expenses while accelerating others. NOI can also be increased by raising rents and other fees, while simultaneously decreasing reasonably necessary operating expenses.
This is one of the reasons it’s absolutely essential for investors to keep accurate and detailed financial records with a system like Landlord Studio for all their investments. This data will inform future potential income and expenses as well as provide lenders with clear historical proof of an investor’s ability to achieve a positive NOI.
Learn more about how you can streamline your rental management with Landlord Studio →