Net operating income (NOI)

Before you rely on it

What to check

Deduct a management allowance and a realistic vacancy figure even if you self-manage and are fully let.

The common error

Where people go wrong with net operating income (NOI)

Omitting management because you do it yourself. Your time is a real cost, the next owner will pay for it, and a valuation built without it is overstated by exactly that amount.

Worked through

Net operating income (NOI) in plain numbers

A small apartment building collects $120,000 a year in potential rent. Vacancy and collection losses take 5%, or $6,000, leaving $114,000. Operating expenses are $42,000: property taxes, insurance, repairs, utilities and management. Net operating income is $114,000 − $42,000, or $72,000. Mortgage payments are not included, and neither are depreciation or income taxes. At a 6% cap rate this NOI supports a value of $1,200,000. Reduce expenses by $5,000 and NOI rises to $77,000, adding about $83,000 to the value at the same rate. Because value is a multiple of NOI, small operating gains are magnified.

Easily confused

Net operating income (NOI) and its neighbours

NOI is not net income, cash flow or EBITDA. Net income subtracts interest, depreciation and taxes. NOI stops before financing and taxes, so it describes the property itself. Cash flow after debt service subtracts loan payments from NOI. EBITDA is a similar idea for operating businesses but may include different items. NOI also excludes capital expenditures such as a new roof, which affect real returns but are not treated as operating expenses. Definitions vary, so check what a seller includes.

In real decisions

Where net operating income (NOI) turns up

Investors and appraisers use NOI to value income properties through the cap rate; lenders divide it by debt service to compute DSCR; owners track it to judge management performance. It helps compare buildings regardless of how each is financed. Buyers rebuild the seller's NOI with their own expense assumptions. It is the central number in most commercial real estate analysis.

Know the edges

Where net operating income (NOI) stops being reliable

Sellers can present optimistic NOI by understating expenses or vacancy. Reserves for replacements are often excluded but real. NOI reflects one period and may not represent the next. Rent growth, lease terms and tenant quality matter beyond the figure. Verify the numbers with rent rolls, operating statements and tax bills before relying on them.

Quick answers

What people ask about net operating income (NOI)

Are mortgage payments part of NOI? No. NOI excludes debt service, depreciation and income taxes, so it describes the property before financing.

Do capital repairs count? Usually not. Major replacements are capital items outside NOI. Many buyers deduct a reserve for them to reach a more realistic figure.

How can I raise NOI? Increase rents where the market allows, reduce vacancy and control operating expenses. Each dollar gained raises value by the inverse of the cap rate.

What expenses are excluded? Mortgage payments, depreciation, income taxes and capital improvements. Include property taxes, insurance, maintenance, utilities and management.