Net Operating Income (NOI)
Net Operating Income (NOI) is a property's gross income minus operating expenses, calculated as Gross Income - Operating Expenses. NOI excludes mortgage payments, depreciation, and capital expenditures, making it the key metric for evaluating commercial real estate profitability.
Exam Tip
NOI = Gross Income - Operating Expenses. EXCLUDES mortgage payments, depreciation, and capital expenditures. Used with cap rate to determine property value: Value = NOI ÷ Cap Rate.
What is Net Operating Income (NOI)?
Net Operating Income (NOI) is the primary metric used to evaluate the profitability of income-producing real estate. It represents the annual income generated by a property after deducting all operating expenses but before debt service and income taxes.
The NOI Formula
NOI = Gross Operating Income - Operating Expenses
Or expanded:
NOI = (Potential Gross Income - Vacancy/Collection Loss + Other Income) - Operating Expenses
What's Included in Gross Income
| Income Source | Description |
|---|---|
| Rental Income | Base rent from all units |
| Parking Fees | Monthly or transient parking |
| Laundry Income | Coin-operated machines |
| Storage Fees | Additional storage rentals |
| Pet Fees | Pet rent and deposits |
| Late Fees | Fees from late rent payments |
| Vacancy Loss | Deduction for unoccupied units |
What's Included in Operating Expenses
| Expense Category | Examples |
|---|---|
| Property Taxes | Annual real estate taxes |
| Insurance | Property and liability insurance |
| Utilities | Water, electric, gas (if owner-paid) |
| Maintenance | Repairs, landscaping, cleaning |
| Management Fees | Property management costs |
| Professional Fees | Accounting, legal services |
| Advertising | Marketing vacant units |
What NOI Excludes (Critical for Exam)
| Excluded Item | Reason |
|---|---|
| Mortgage Payments | Financing varies by owner |
| Principal & Interest | Not an operating expense |
| Depreciation | Non-cash accounting entry |
| Income Taxes | Varies by owner's tax situation |
| Capital Expenditures | Major improvements, not operations |
NOI Calculation Example
| Item | Amount |
|---|---|
| Potential Gross Income | $120,000 |
| Less: Vacancy (5%) | -$6,000 |
| Effective Gross Income | $114,000 |
| Less: Operating Expenses | -$45,000 |
| Net Operating Income | $69,000 |
Using NOI to Calculate Cap Rate and Value
| Formula | Calculation |
|---|---|
| Cap Rate | NOI ÷ Property Value |
| Property Value | NOI ÷ Cap Rate |
Example: If NOI = $69,000 and Cap Rate = 6% Property Value = $69,000 ÷ 0.06 = $1,150,000
NOI vs. Cash Flow
| Metric | Includes Debt Service |
|---|---|
| NOI | No - before debt |
| Cash Flow | Yes - after debt payments |
Cash Flow = NOI - Annual Debt Service
Why NOI Matters in Commercial Real Estate
| Use | Purpose |
|---|---|
| Property Valuation | Calculate value via cap rate |
| Investment Comparison | Compare properties objectively |
| Loan Qualification | Lenders use NOI for DSCR |
| Performance Tracking | Monitor property profitability |
Exam Alert
Key exam points for NOI:
- Formula: Gross Income - Operating Expenses = NOI
- EXCLUDES: Mortgage payments (principal & interest), depreciation, capital expenditures, income taxes
- INCLUDES: Property taxes, insurance, maintenance, management fees, utilities
- Cap Rate Formula: NOI ÷ Property Value
- Value Formula: NOI ÷ Cap Rate
- NOI measures property performance INDEPENDENT of financing
Study This Term In
Related Terms
Cap Rate (Capitalization Rate)
Real EstateCap rate is a real estate investment metric calculated by dividing a property's Net Operating Income (NOI) by its current market value or purchase price, expressed as a percentage to evaluate potential return.
Gross Rent Multiplier (GRM)
Real EstateThe Gross Rent Multiplier (GRM) is a property valuation metric calculated by dividing the property price by its annual gross rental income, providing a quick method to compare investment properties and estimate how many years of gross rent would equal the purchase price.