Net operating income, or NOI, is the starting point for nearly every investment property analysis. It is the income a property produces after operating expenses and before financing and income taxes. Cap rates, debt service coverage and valuations of income properties all start from it.
It is also easy to get wrong, usually by trusting a seller’s figures or leaving out expenses.
The Formula
NOI = Effective gross income − Operating expenses
Where effective gross income is the rent the property could collect, minus vacancy and collection losses, plus other income.
Step 1: Gross Scheduled Rent
Start with the rent for every unit for a full year at current market rents. Use actual leases for occupied units, and check them against comparable rentals. If current rents are below market, note that separately: it may be an opportunity, but it is not income yet.
Step 2: Subtract Vacancy and Credit Loss
No property is fully occupied and fully paid every month of every year. Turnover, time between tenants and unpaid rent all reduce income. Use an allowance based on the property type and local rental market, not zero.
Step 3: Add Other Income
Laundry, parking, storage, pet fees and similar income count if they are reliable.
Step 4: Subtract Operating Expenses
Include every cost of running the property:
- Property taxes, estimated as they will be after your purchase, since Florida generally reassesses at the sale price
- Insurance: property, wind, flood and liability. In South Florida this can be one of the largest expenses, so get a quote
- Repairs and maintenance
- Property management, even if you plan to self-manage, because your time has value and a buyer or lender will count it
- Utilities the owner pays, such as water, sewer, trash and common-area electricity
- Association fees, for condos
- Landscaping, pest control, licenses, accounting and legal
- Reserves for replacements, if you include them (see the FAQ below)
Do not include mortgage payments, depreciation or income taxes. They are not operating expenses.
A Hypothetical Example
The following is a hypothetical four-unit building for illustration only. Every figure is an assumption, not a market estimate.
| Line | Annual amount |
|---|---|
| Gross scheduled rent (4 units × $2,000 × 12) | $96,000 |
| Less vacancy and credit loss (5%) | −$4,800 |
| Plus other income (laundry) | $1,200 |
| Effective gross income | $92,400 |
| Property taxes | −$14,000 |
| Insurance | −$12,000 |
| Repairs and maintenance | −$6,000 |
| Property management (8% of effective gross income) | −$7,392 |
| Owner-paid utilities | −$4,800 |
| Reserves for replacements | −$2,400 |
| Other (landscaping, pest control, accounting) | −$2,000 |
| Total operating expenses | −$48,592 |
| Net operating income | $43,808 |
In this example, operating expenses are a little over half of effective gross income. Investors new to South Florida are sometimes surprised by that ratio, mainly because of taxes and insurance.
Common Mistakes
- Using the seller’s expenses as-is. Taxes based on an old assessment and an insurance policy that will be repriced at renewal can make a property look better than it will perform.
- Leaving out management or reserves. Both are real costs, even if they are not paid every month.
- Counting below-market rents at market levels. Raising rents takes time and may involve turnover.
- Ignoring deferred maintenance. A roof or electrical system near the end of its life is a capital cost that the NOI alone will not show.
What to Do With NOI
Once you have a realistic NOI, you can compare it with the price to find the cap rate, and with your financing to see whether the property covers its debt and what cash return it produces on your investment. See cash-on-cash return vs. cap rate for the next step.
Mariya runs these numbers with investors before an offer is made, using property-specific taxes, insurance quotes and rent comparables. Request an investment analysis, or call (646) 678-6477.
Frequently Asked Questions
Does NOI include the mortgage payment?
No. NOI is calculated before debt service, so it describes the property's performance regardless of how it is financed. Mortgage payments are subtracted afterwards to find cash flow.
Should capital reserves be included in operating expenses?
Practices vary. Many investors and lenders include a reserve for replacements in their underwriting even though it is not a true operating expense. What matters is consistency: compare properties using the same method.
Why is the seller's NOI different from mine?
Sellers' figures often reflect their own costs, such as taxes based on an old assessment, self-management or an insurance policy that will not carry over. Rebuild the NOI using the expenses you will actually have as the new owner.
What is a good NOI?
There is no single good number. NOI is an input: it is compared with the price (cap rate), with the debt payments (debt service coverage) and with your cash invested (cash-on-cash return).
This article is educational and is not investment, tax or legal advice. All examples are hypothetical, use assumed figures and do not represent any actual property, rate quote or expected return. No return is promised or guaranteed. Real estate investments involve risk, including loss of capital. Consult your own CPA, attorney, lender and financial advisor before investing. Mariya Stoyanova, P.A. is a licensed real estate sales associate, not a financial advisor.