What is NOI?
NOI, or Net Operating Income, is a fundamental financial metric used to measure the profitability of an income-producing real estate property. It represents the total income generated by a property after subtracting all operating expenses, but before accounting for financing costs, taxes, depreciation, and capital expenditures.
Essentially, NOI shows how much cash flow a property generates from its core operations. This makes it a critical number for investors, lenders, and property owners when evaluating the performance and value of real estate assets.
How does NOI work?
NOI works by capturing the true operational performance of a property. To calculate it, you start with the property’s gross rental income, then subtract vacancy losses to arrive at effective gross income. From there, you deduct all operating expenses necessary to run and maintain the property.
Operating expenses typically include property management fees, insurance, property taxes, utilities, maintenance, repairs, and landscaping. Importantly, NOI does not include mortgage payments, income taxes, or one-time capital improvements like a new roof or HVAC system.
By excluding financing and tax considerations, NOI provides a standardized way to compare different properties regardless of how they’re financed or structured. This allows investors to assess the property itself, not the financing strategy behind it.
The NOI formula
The formula for calculating NOI is straightforward:
NOI = Gross Rental Income – Vacancy Loss – Operating Expenses
Alternatively, it can be expressed as:
NOI = Effective Gross Income – Operating Expenses
Where Effective Gross Income = Gross Rental Income – Vacancy Loss
Real-world application of NOI in real estate
In practice, NOI is the foundation for several important real estate calculations. Most notably, it’s used to determine a property’s capitalization rate (cap rate), which is calculated by dividing NOI by the property’s purchase price or current market value.
For example, if an apartment building generates $120,000 in annual NOI and is valued at $1,500,000, the cap rate would be 8%. This helps investors quickly compare investment opportunities across different properties and markets.
Lenders also rely heavily on NOI when underwriting commercial real estate loans. They use it to calculate the debt service coverage ratio (DSCR), which compares NOI to annual debt payments to ensure the property generates sufficient income to cover its mortgage obligations.
How NOI is used
Real estate professionals use NOI in multiple ways throughout the investment lifecycle. During acquisition, investors analyze historical NOI trends to assess property performance and forecast future returns. A rising NOI typically indicates strong demand, effective management, or successful rent increases.
Property managers track NOI regularly to monitor operational efficiency. By comparing actual NOI to budgeted projections, they can identify cost overruns, revenue shortfalls, or opportunities for improvement. This ongoing measurement helps optimize property performance over time.
Additionally, NOI serves as a key input in property valuations. Appraisers and investors use the income capitalization approach, which divides NOI by an appropriate cap rate to estimate market value. This method is particularly common for commercial properties like office buildings, retail centers, and multifamily apartments.
In other words
Think of NOI as the property’s operating profit—what’s left after paying all the bills to keep the lights on and the property running smoothly. It’s the money the property itself earns before anyone considers how it was purchased, who owns it, or how it’s financed.
NOI is to real estate what EBITDA is to corporate finance: a standardized measure of operational performance that strips away financial engineering. Whether you’re comparing a shopping center in Dallas to an apartment complex in Seattle, NOI provides an apples-to-apples metric that reveals the true earning power of each asset.
