How To Calculate NOI: A Guide To Net Operating Income

If you’re a real estate investor, understanding Net Operating Income (NOI) is critical. NOI is one of the most important financial metrics used to evaluate a property’s profitability.

It helps property owners and prospective investors compare different properties and make smarter investment decisions.

This guide will break down how to calculate NOI, why it’s important, and how it affects the real estate market, property value, and overall financial health of an investment property.

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What Is Net Operating Income (NOI)?

NOI measures how much income a rental property or commercial real estate asset generates after subtracting necessary operating expenses.

The NOI helps determine whether an investment is financially sound.

NOI Formula:

NOI = Total Revenue - Operating Expenses

This calculation excludes mortgage payments, capital expenditures, depreciation, and income taxes, as these are considered financing or ownership costs rather than operational costs.

Real estate professionals use NOI to calculate other important metrics like the capitalization rate (cap rate) and debt service coverage ratio.

These calculations help you make informed investment decisions and compare properties on an equal basis.

Why Is NOI Important?

NOI provides a clear picture of a property’s financial performance. Real estate investors use it to:

• Assess cash flow and profitability

• Compare investment opportunities

• Determine a property’s value using the cap rate

• Analyze a property’s ability to cover debt payments (Debt Service Coverage Ratio)

• Identify areas to reduce operating costs and increase revenue

A higher NOI generally indicates a well-performing investment, while a negative NOI means the property isn’t generating enough income to cover expenses.

Breaking Down NOI: Revenue vs. Expenses

Revenue Sources in NOI

Total revenue includes all income sources the property generates, such as:

• Rental income from tenants

• Parking fees

• Laundry services

• Storage unit rentals

• Amenity fees (e.g., gym access, pet fees)

• Late payment fees

• Any other additional income from the property

Operating Expenses in NOI

The property’s operating expenses include all necessary costs required to run the property. These typically include:

• Property taxes

• Insurance premiums

• Utilities (if paid by owner)

• Maintenance costs (repairs, landscaping, snow removal, etc.)

• Property management fees

• Janitorial services (for office buildings or multi-unit rentals)

Example: If your rental property generates $200,000 in total income but has $50,000 in operating expenses, the NOI is: The NOI is $150,000.

Adjusting NOI for Vacancy Rates and Other Income

To get a more accurate NOI, adjust your gross operating income for vacancy rates and potential additional income.

Effective Gross Income = Gross Potential Income – Vacancy Losses + Other Income

Example: If a property has a 5% vacancy rate and typically earns $100,000 in rental income, then vacancy losses are $5,000. Adjust your NOI accordingly.

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How NOI Affects Property Value

Investors often use NOI calculations to determine the market value of a property using the capitalization rate (Cap Rate) formula:

Property Value = NOI/Cap Rate

Example: If a property generates $120,000 in NOI and the market cap rate is 6%, then the property’s estimated value is:

The property is worth $2 million.

A higher NOI leads to a higher property value, making it more attractive to prospective investors.

Using NOI to Make Investment Decisions

Investors compare NOI across different properties to decide where to invest their money. A property with a strong NOI but a lower purchase price might be a great investment, while one with a high purchase price but weak NOI might not be worth it.

Factors That Affect NOI

Several factors can impact a property’s NOI, including:

• Market conditions (rising or falling rental demand)

• Property management efficiency

• Vacancy rates

• Maintenance fees and repair costs

• Property taxes (which vary by location)

• Financing costs (though not included in NOI calculations, they affect overall profitability)

Example: If property taxes increase, NOI decreases, reducing the property’s profitability and potentially lowering its market value.

Comparing NOI Across Property Types

NOI differs based on property type. Here’s how it varies:

Property Type	Typical NOI Characteristics
Office Buildings	Higher maintenance costs, stable NOI
Retail Properties	NOI depends on lease terms and tenant sales
Multifamily Units	NOI affected by tenant turnover and vacancies
Industrial Spaces	Lower maintenance, higher NOI margins
Short-Term Rentals	NOI fluctuates based on seasonal demand

NOI and Debt Service Coverage Ratio (DSCR)

Lenders use NOI to assess a borrower’s ability to cover debt payments through the Debt Service Coverage Ratio (DSCR):

DSCR = NOI/Annual Debt Payments

Most lenders require a minimum DSCR of 1.25, meaning the property generates 25% more NOI than needed for loan payments.

Example: If your NOI is $150,000 and your debt payments are $120,000, then your DSCR is:  150,000/120,000 = 1.25

This meets the lender’s requirement for financing.

Final Thoughts

Understanding how to calculate NOI is essential for making investment decisions, assessing a property’s financial performance, and determining its market value. By tracking your NOI margin and comparing similar properties, you can find better investment opportunities and make more informed choices.

Whether you’re investing in commercial real estate, rental properties, or office buildings, always keep an eye on NOI to maximize cash flow and long-term growth.

For real estate investors, knowing how to adjust for vacancy rates, operating expenses, and property management fees can help you optimize profitability and secure better financing options.

Now that you know how to calculate and use NOI, you’re ready to make smarter real estate investment choices.

FAQs

What factors do I include when calculating the net operating income for a rental property?

When calculating NOI for a rental property, include all revenue sources such as rental income, parking fees, laundry income, and other ancillary income.

From this total, subtract operating expenses directly tied to property management.

Operating expenses typically include property taxes, insurance, maintenance costs, property management fees, utilities paid by the owner, and landscaping.

Do not include mortgage payments, capital expenditures, depreciation, or income taxes in your NOI calculation.

Can you explain the relationship between the capitalization rate and net operating income?

The capitalization rate (cap rate) and NOI have a direct mathematical relationship expressed as: Value = NOI / Cap Rate.

This formula helps determine a property’s market value based on its income.

If you know a property’s NOI and the typical cap rate for similar properties in the area, you can estimate the property’s value.

Inversely, if you know a property’s value and NOI, you can calculate its cap rate to compare with other investments.

How can I differentiate between net operating income and EBITDA when analyzing financial performance?

NOI is specific to real estate and excludes mortgage interest and property-level income taxes.

EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) is used for businesses across all industries.

While both metrics exclude interest, taxes, and depreciation, EBITDA may include more corporate-level expenses that wouldn’t be included in NOI.

NOI focuses solely on property-level operations while EBITDA provides a broader view of business performance.

Could you provide the formula to determine a rental property’s net operating income in managerial accounting?

The formula for calculating NOI in managerial accounting is: NOI = Gross Income – Operating Expenses.

Gross income includes all potential rental income (assuming full occupancy) minus vacancy losses, plus all additional income sources.

Operating expenses include all costs necessary to maintain and operate the property, excluding capital expenditures, debt service, and depreciation.

What indicators should be considered as a sign of a good net operating income for an investment property?

A good NOI should be high enough to provide a positive cash flow after accounting for debt service.

Compare the property’s NOI to similar properties in the same market to ensure competitive performance.

The NOI should yield a reasonable cap rate based on the property’s purchase price and location.

Look for year-over-year NOI growth, which indicates effective management and increasing property value.

Should net operating income be reported on a monthly or annual basis for accurate financial analysis?

NOI is typically reported on an annual basis for comprehensive financial analysis and property valuation.

Annual reporting provides a complete picture that accounts for seasonal variations in income and expenses.

However, tracking NOI monthly can help identify trends, address problems quickly, and make timely management decisions.

For the most accurate analysis, maintain monthly records but use annualized figures when evaluating overall property performance or comparing investments.