NOI (Net Operating Income)
A property's annual income after operating expenses but before debt service and taxes. NOI = gross income − operating expenses. It's the foundation of cap rate and income-based valuation.
Net operating income (NOI) is the annual income a property produces after paying all operating expenses but before paying the mortgage, income taxes, or capital expenditures:
NOI = Effective Gross Income − Operating Expenses
NOI is the single most important profitability figure in income-property investing. It feeds directly into cap rate and the income-capitalization valuation lenders and appraisers use on rental collateral.
What counts as income
Start with gross potential rent, then subtract a vacancy and credit-loss allowance to get effective gross income. Add any other income — laundry, parking, pet fees, late fees.
What counts as an operating expense
Operating expenses are the recurring costs of keeping the property running:
- Property taxes
- Insurance
- Property management
- Repairs and routine maintenance
- Utilities the owner pays
- HOA dues, landscaping, trash, pest control
What is deliberately excluded
Three things are not in NOI, and forgetting this is a classic mistake:
- Debt service (mortgage principal and interest) — NOI is unleveraged.
- Income taxes — those are the owner's, not the property's.
- Capital expenditures — a new roof or HVAC is a capital item, not an operating expense (though smart investors reserve for it separately).
A worked example
| Line | Annual |
|---|---|
| Gross potential rent | $48,000 |
| Less vacancy (5%) | −$2,400 |
| Effective gross income | $45,600 |
| Property taxes | −$7,200 |
| Insurance | −$1,800 |
| Management (8%) | −$3,648 |
| Repairs/maintenance | −$3,000 |
| NOI | $29,952 |
Why lenders care
On a DSCR loan, the property's income covers the loan, so NOI (and the rent that drives it) underpins the appraisal and the leverage available. Note that DSCR itself uses gross rent over PITIA rather than NOI — but NOI is what tells you whether the deal is actually a sound investment once real operating costs are accounted for. A property can clear the DSCR test and still have thin NOI once management and reserves are honest.
Frequently asked questions
Does NOI include the mortgage payment?
No. NOI is calculated before debt service — it's the income the property produces regardless of how it's financed. Subtract your mortgage payment from NOI to get pre-tax cash flow. This is what makes NOI useful for comparing properties on equal footing.
Is capital expenditure part of operating expenses?
Strictly, no. NOI excludes capital expenditures like a new roof, HVAC replacement, or major systems. Those are capitalized, not expensed. That said, prudent investors set aside a capex reserve, because ignoring it overstates a property's true long-run profitability.
How does NOI relate to cap rate?
Cap rate equals NOI divided by property value. Rearranged, value equals NOI divided by cap rate. So NOI is the numerator that drives income-based valuation — increasing NOI (higher rent or lower expenses) directly increases what the property is worth at a given cap rate.