What Is NOI (Net Operating Income)?
NOI answers one question: how much does this property earn from rent and operations, ignoring how you financed it? A duplex bringing in $36,000/year in rent with $14,400 in operating expenses and 6% vacancy has an NOI of $19,440. That number feeds into cap rate (NOI ÷ property value) and DSCR (NOI ÷ debt service). Lenders and investors use it to compare properties regardless of financing — your mortgage is your choice, not the property's.
NOI (net operating income) is what a property earns from operations each year. Rental revenue minus vacancy loss and operating expenses. Before you subtract the mortgage, CapEx, or taxes.
At a Glance
- Formula: Gross Rental Income − Vacancy Loss − Operating Expenses
- Operating expenses include: property taxes, insurance, maintenance, property management, utilities (if landlord-paid), reserves
- Operating expenses exclude: mortgage payments, capital expenditures, depreciation
- Multifamily OER ~41% in 2024; single-family typically 35–50% depending on market
- A $50,000 NOI error at a 5% cap rate swings property value by $1,000,000
NOI = Gross Rental Income - Vacancy Loss - Operating Expenses
How It Works
The formula. Start with gross rental income — what you'd collect if every unit rented at market rate all year. Subtract vacancy loss (5–10% for typical residential; use actual market data, not seller optimism). That gives you effective gross income. Then subtract every recurring cost to keep the property running: property taxes, insurance, maintenance, property management (8–12% of rent), utilities you pay, landscaping, pest control, reserves for routine replacements. The result is NOI.
What stays out. Mortgage principal and interest never touch NOI. That's the #1 mistake — including debt service in operating expenses double-counts financing and artificially deflates the number. Lenders and appraisers use NOI to evaluate the property, not your loan choice. Capital expenditures (new roof, HVAC, major renovations) go below the line too. One-time improvements, not recurring operations. Depreciation is a tax accounting entry, not cash; it doesn't belong in NOI.
Why it matters. NOI is the numerator in the cap rate formula. Cap rate = NOI ÷ property value. So NOI drives valuation directly. A $320,000 property with $25,600 NOI = 8% cap. Mess up the NOI by $5,000 and you've misvalued the property by $62,500 at that cap. Lenders use NOI for DSCR — they divide NOI by annual debt service to see if the property can cover the loan. Get NOI wrong and your DSCR is wrong. Your approval's at risk.
OER reality check. Multifamily operating expense ratios averaged 41% in 2024. Single-family runs 35–50% depending on age, condition, and market. If a seller's pro forma shows 25% OER on a 20-year-old building? Dig deeper. Insurance, labor, and materials have pushed expenses up 10–12% in recent years. Use actuals or conservative benchmarks.
Real-World Example
Memphis duplex. You're evaluating a 2-unit at $185,000. Each unit rents for $1,200/month. Gross rental income: $28,800/year. Vacancy rate in Memphis runs 6% — call it $1,728. Effective gross income: $27,072.
Operating expenses:
- Property taxes: $2,220
- Insurance: $1,400
- Maintenance (1% of value): $1,850
- Property management (10%): $2,880
- Reserves (5% of rent): $1,440
- Total: $9,790
NOI = $27,072 − $9,790 = $17,282
That's your cap rate numerator. $17,282 ÷ $185,000 = 9.3% cap. If the seller claimed $22,000 NOI — maybe they forgot vacancy, or used a 30% expense ratio — you'd be valuing the property at $244,000 instead of $185,000. That $4,718 difference in NOI? A $59,000 swing in valuation at 8% cap. Verify every line item yourself.
Pros & Cons
- Financing-independent — apples-to-apples comparison across properties regardless of loan structure
- Feeds cap rate and DSCR — the two metrics lenders and appraisers care about most
- Standardized industry metric — brokers, lenders, and investors all speak the same language
- Exposes operational efficiency — low OER means the property runs lean; high OER signals trouble
- Valuation backbone — plug market cap rate and NOI to estimate property value
- Ignores your actual cash — a property can have strong NOI and negative cash flow if debt service is high
- NOI calculations vary wildly — sellers use pro forma rents, inflated expense ratios, or optimistic vacancy
- Single-period snapshot — doesn't tell you if NOI is trending up or down
- CapEx excluded — that $18,000 roof replacement next year? Not in the number
- Requires discipline — easy to forget vacancy, include mortgage, or misclassify CapEx as operating
Watch Out
Including the mortgage. The #1 error. Mortgage payments are debt service, not operating expenses. Subtract them into NOI and you're mixing financing with operations. Lenders and appraisers will recalculate. A property that "doesn't cash flow" might still have solid NOI — the problem's the loan, not the property.
Ignoring vacancy. Sellers often show gross potential rent. Real markets have vacancy. Memphis 6%, San Jose 3%, Cleveland 8%. Use a vacancy rate that matches your market or you'll overstate NOI.
Pro forma vs. actuals. A seller's "stabilized NOI" assumes projected rents that haven't materialized and expenses that haven't been paid. Pull actual rent rolls. Check real tax bills. Verify insurance quotes. A $50,000 NOI error at 5% cap = $1,000,000 valuation error.
CapEx creep. Roof, HVAC, major renovations are capital expenditures. Don't lump them into operating expenses to inflate NOI. Reserves for routine replacements (e.g., $1,000/year for roof replacement) are sometimes included — but one-time $25,000 roof replacements are not.
Ask an Investor
The Takeaway
NOI is the property's income before you subtract the mortgage. It feeds cap rate and DSCR — the two metrics that decide whether a deal gets financed and how it's valued. Verify every line item yourself. Don't trust seller pro formas. Never include mortgage payments in operating expenses. Get NOI right and the rest of your analysis follows.