Net operating income — NOI — sits at the center of most rental property analysis. Cap rate is built on it. Lenders use it to size loans. Appraisers use it to estimate value. And cash flow starts from it.
Because so much depends on NOI, the details of what goes into it matter. This guide walks through each component and the items that are commonly — and incorrectly — included or left out.
The NOI formula
Effective gross income (EGI) = Potential gross income − Vacancy & credit loss
NOI = EGI − Operating expenses
The short version: NOI is everything the property collects, minus everything it costs to operate, before any loan payment and before income taxes.
What goes in: income
Scheduled rent. The rent from every unit at current (or market) rates for a full year, as if fully occupied.
Other income. Recurring income the property generates beyond rent: laundry machines, parking spaces, storage units, pet rent, late fees that are reliably collected, and utility reimbursements from tenants.
Vacancy and credit loss. A deduction for units that sit empty and rent that’s billed but never collected. It’s usually expressed as a percentage of potential gross income.
What goes in: operating expenses
Operating expenses are the ongoing costs required to keep the property running and leased:
- Property taxes
- Insurance
- Utilities paid by the owner (water, sewer, trash, common-area electric)
- Property management fees
- Repairs and maintenance
- A reserve for capital expenditures (roofs, HVAC, appliances) — included by many analysts, though some list it separately as “below the line”
- Landscaping, snow removal, cleaning
- Administrative costs: accounting, licenses, advertising, legal fees for leases
- HOA or condo fees, if any
What stays out
This is where NOI calculations most often go wrong. The following are not operating expenses:
- Mortgage principal and interest. Debt service depends on how the property is financed, not how it operates. It’s subtracted after NOI to get cash flow.
- Depreciation. It’s a tax concept, not a cash expense.
- Income taxes. These depend on the owner, not the property.
- One-time capital improvements. A full renovation or a new addition is a capital investment, not an operating cost (though the ongoing CapEx reserve may be included, as noted above).
- Owner’s personal expenses. Travel, a home office or a car shouldn’t be in a property’s NOI, even if they’re tax-deductible for the owner.
A worked example
A fourplex renting at $1,250 per unit
The property also collects $40 per unit per month for off-street parking. The analysis uses a 6% vacancy and credit loss allowance.
| Line item | Annual |
|---|---|
| Scheduled rent (4 × $1,250 × 12) | $60,000 |
| Parking income | $1,920 |
| Potential gross income | $61,920 |
| Vacancy & credit loss (6%) | −$3,715 |
| Effective gross income | $58,205 |
| Property taxes | −$7,800 |
| Insurance | −$3,600 |
| Water & sewer (owner-paid) | −$4,200 |
| Management (8% of EGI) | −$4,656 |
| Repairs & maintenance ($900/unit) | −$3,600 |
| CapEx reserve ($600/unit) | −$2,400 |
| Admin & accounting | −$600 |
| Net operating income | $31,348 |
Hypothetical numbers for illustration.
Operating expenses here total $26,856, or 46% of effective gross income. That percentage is called the operating expense ratio, and it’s a quick way to compare how expensive different properties are to run.
How NOI feeds other metrics
Once NOI is known, several other figures follow directly:
- Cash flow: NOI minus debt service. If this fourplex had $26,400 in annual loan payments, cash flow would be $4,948.
- Cap rate: NOI divided by value or price.
- Implied value: NOI divided by a market cap rate. At a 7% cap rate, this NOI implies a value of about $447,835.
- Debt service coverage ratio (DSCR): NOI divided by annual debt service — a measure lenders use to judge whether income covers the loan.
That last point shows why including the mortgage in NOI causes real problems. Subtract the $26,400 loan payment as if it were an operating expense and “NOI” drops to $4,948 — which would make the cap rate, implied value and DSCR all wrong at once.
Actual NOI vs. pro forma NOI
There are two common ways to present NOI:
Actual (or trailing) NOI uses what the property really collected and spent, often over the last 12 months (a “T-12”). It reflects the property as it’s currently operated — including any below-market rents or deferred maintenance.
Pro forma NOI projects what the property could produce under different assumptions: market rents, a new management approach, or lower expenses after improvements. It’s forward-looking and depends entirely on those assumptions.
Both are legitimate tools. The important thing is knowing which one is being used — and noticing when a listing quotes a cap rate based on pro forma NOI next to a price based on today’s property.
Common NOI mistakes
Using the seller’s expense figures without checking them. Some listings show taxes at the seller’s assessed value, which may change after a sale, or leave out management because the owner self-managed.
Skipping vacancy. A fully occupied property today still has turnover over time.
Omitting CapEx entirely. Whether it’s inside NOI or just below it, large replacements are real costs and belong somewhere in the analysis.
Counting reimbursements twice. If tenants reimburse water, include the reimbursement as income and the full water bill as an expense — or net them, but not both.
The takeaway
NOI is income after vacancy and operating expenses, before financing and income taxes. Getting it right means including every recurring operating cost and leaving out the mortgage, depreciation and one-time capital projects. Because cap rate, value, DSCR and cash flow all build on it, a small error in NOI carries through to every number that follows.