How to Calculate Net Operating Income (NOI)
Net operating income is effective gross income less operating expenses. See the full calculation, what to exclude and the errors that inflate it.
Key takeaways
- NOI = effective gross income less operating expenses, before debt, capital expenditure, depreciation and tax.
- Check whether a quoted NOI is before or after replacement reserves before comparing properties.
- Missing management fees, unrealistic vacancy and stale property taxes are the usual causes of overstated NOI.
Net operating income, or NOI, is the income a property produces after operating expenses and before debt service, capital expenditure, depreciation and income tax. It is the figure that drives value, loan sizing and almost every return metric, which is why lenders and buyers examine how it was built before they look at anything else.
The calculation
NOI = effective gross income - operating expenses. Effective gross income is gross potential rent, less vacancy and credit loss, plus other income.
A worked example
- Gross potential rent: $1,200,000
- Less vacancy and credit loss at 5%: $60,000
- Plus other income (parking, storage): $40,000
- Effective gross income: $1,180,000
- Less operating expenses (taxes, insurance, utilities, repairs, management, payroll): $430,000
- Net operating income: $750,000
What NOI excludes
- Debt service. NOI describes the property, not how it is financed.
- Capital expenditure, tenant improvements and leasing commissions. These sit below NOI.
- Depreciation and amortisation, which are accounting entries rather than cash.
- Income tax and the owner's entity-level costs.
Some analysts deduct a recurring replacement reserve above the line and call the result NOI. Neither convention is wrong, but comparing one property's figure with reserves against another's without is a common source of mispricing.
Errors that inflate NOI
- Using asking rents rather than contracted rents.
- Assuming no vacancy because the building is currently full.
- Leaving out a management fee because the owner manages the property personally. A buyer or lender will add one back.
- Carrying forward property taxes that will be reassessed after a sale.
- Treating one-off income, such as a lease surrender payment, as recurring.
From NOI to value and debt
Divide NOI by a cap rate to estimate value - see cap rate explained. Divide it by annual debt service to get the debt service coverage ratio a lender will test - see loan sizing with LTV, DSCR and debt yield. Because a small error in NOI is multiplied through both, it is worth building it line by line. That is the starting point of every acquisition model we build.
Frequently asked questions
Is NOI the same as cash flow?
No. Cash flow to the owner is NOI less capital expenditure, leasing costs and debt service. A property can have healthy NOI and weak cash flow if it needs heavy capital spending or carries expensive debt.
Is NOI the same as EBITDA?
They are close relatives. Both exclude financing, depreciation and tax. NOI is a property-level measure, while EBITDA is a company-level measure that also includes corporate overheads.
Should a management fee be included in NOI if I self-manage?
Yes. Lenders and buyers include a market-rate management fee whether or not the current owner pays one, because the next owner will have to.