Net Operating Income (NOI)
Also called: NOI
Net operating income is a property's effective gross income minus all operating expenses, excluding debt service, capital expenditures, depreciation, and income taxes.
NOI is the foundation of commercial real estate valuation. Cap rate, DSCR, debt yield, and the sale price itself are all computed from it, which means an error in NOI propagates into every other number in the model. It is the single line most worth verifying independently.
The definitional boundary is where disputes happen. NOI excludes debt service and capital expenditures by convention, but the treatment of replacement reserves, management fees, and non-recurring items varies by who prepared the statement. A seller's NOI that omits a market management fee and carries no reserve will always look better than the same property underwritten by a lender.
How to calculate net operating income
NOI = Effective Gross Income - Operating Expenses- Effective Gross Income:
- Gross potential rent less vacancy and credit loss, plus other income
- Operating Expenses:
- Taxes, insurance, utilities, repairs, payroll, management, and administrative costs
Worked example
A 40-unit property, annualized:
- Gross potential rent
- $672,000
- Vacancy and credit loss
- ($47,000)
- Other income
- $31,000
- Effective gross income
- $656,000
- Operating expenses
- ($266,000)
Rules of thumb
- Rebuild NOI from the trailing twelve month statement rather than accepting the offering memorandum's proforma. The gap between the two is the seller's business plan, not yours.
- Always add a management fee at market, typically 3% to 4% of effective gross income, even when the seller self-manages.
- Reassessment of property taxes at your purchase price is the most common single omission in a seller's proforma.
Calculate net operating income
Related terms
- Effective Gross Income (EGI)
Effective gross income is gross potential rent less vacancy, concessions, and credit loss, plus other income such as parking, pet fees, and utility reimbursements.
- Capitalization Rate (Cap Rate)
A capitalization rate is a property's net operating income divided by its purchase price, expressed as a percentage, and it represents the unlevered annual yield the property produces at that price.
- Debt Service Coverage Ratio (DSCR)
The debt service coverage ratio is net operating income divided by total annual debt service, and it measures how many times a property's income covers its loan payments.
- Operating Expense Ratio (OER)
The operating expense ratio is total operating expenses divided by effective gross income, expressed as a percentage, and it measures what share of collected revenue is consumed by running the property.
- Trailing Twelve (T12)
A trailing twelve is an operating statement showing a property's actual income and expenses for the most recent twelve months, and it is the primary evidence base for underwriting a multifamily acquisition.