Net Operating Income (NOI) is the annual income a property generates after operating expenses, before accounting for debt service (mortgage payments) and taxes. It is the foundational number in rental property analysis — everything else, including cap rate, property value, and DSCR loan qualification, is derived from it.
The NOI Formula
NOI = Gross Rental Income − Vacancy Loss − Operating Expenses
Or equivalently:
NOI = Effective Gross Income − Operating Expenses
Where Effective Gross Income is what the property actually collects after accounting for vacancies and credit losses.
What to Include in NOI
Gross Rental Income includes:
- Monthly rent × 12 for all units
- Other income: parking fees, laundry, pet fees, storage units, late fees
Vacancy and Credit Loss is typically estimated at 5–10% of gross income depending on the market and property type. It accounts for time between tenants and tenants who don't pay.
Operating Expenses include:
- Property taxes
- Insurance
- Property management fees (typically 8–12% of collected rent)
- Repairs and maintenance (commonly estimated at 1% of property value annually, or $50–100/unit/month)
- Utilities you pay (water, trash, common area electricity)
- Landscaping and snow removal
- HOA fees (if applicable)
- Accounting and legal fees
What is NOT included in operating expenses:
- Mortgage principal and interest (debt service)
- Income taxes
- Depreciation
- Capital expenditures (major improvements like a new roof)
These exclusions are intentional. NOI measures the operating performance of the property itself, independent of how it's financed. This makes it possible to compare properties on equal footing regardless of their financing structure.
A Worked Example
A 4-unit apartment building with each unit renting at $1,200/month:
Gross Rental Income: $1,200 × 4 × 12 = $57,600
Vacancy (5%): -$2,880
Effective Gross Income: $54,720
Operating Expenses:
Property taxes: -$4,800
Insurance: -$2,400
Property management (10%): -$5,472
Repairs & maintenance: -$3,600
Utilities: -$1,200
Total expenses: -$17,472
NOI: $37,248
How NOI Is Used
Cap Rate: The most common use of NOI. Cap rate = NOI ÷ Property Value. A $500,000 property with $37,248 NOI has a cap rate of 7.4%. Cap rate lets you compare the income potential of different properties regardless of financing.
Property Value: Lenders and appraisers use NOI to estimate what a property should be worth in income-based markets: Value = NOI ÷ Market Cap Rate. If similar properties sell at a 6.5% cap rate, the property above would be valued at $37,248 ÷ 0.065 = $573,000.
DSCR (Debt Service Coverage Ratio): Lenders divide NOI by annual debt service to determine if the property generates enough income to cover the mortgage. A DSCR of 1.0 means the property exactly covers the debt; most lenders require 1.20–1.25 or higher.
Cash Flow: NOI minus debt service gives you the property's actual cash flow. A property with $37,248 NOI and $28,000 in annual mortgage payments generates $9,248/year in cash flow.
Common NOI Mistakes
Understating expenses: New investors often forget to include management fees (even if self-managing — your time has value), maintenance reserves, and vacancy. Optimistic expense assumptions produce inflated NOI and overstated returns.
Using scheduled rent instead of actual income: If units are vacant or below market, use actual projected income, not theoretical full-occupancy rent.
Including mortgage payments: NOI by definition excludes debt service. Adding it in is one of the most common calculation errors.
To calculate cap rate from your property's NOI, use the Cap Rate Calculator. For a full cash flow analysis including mortgage, expenses, and vacancy, use the Rental Cash Flow Calculator. To evaluate DSCR loan qualification, use the DSCR Calculator.