Net Operating Income (NOI), Explained

Net operating income is the engine of every real estate valuation: rent minus the costs of running the property. Here is exactly what goes in, what stays out, and a fully worked example on a 4-unit building.

Net operating income (NOI) is a rental property's annual income after operating expenses, before mortgage payments, income taxes, and depreciation. A 4-unit building collecting $57,600 in rent with a 5% vacancy allowance, $1,200 of other income, and $19,377.60 of operating expenses has an NOI of $36,542.40 per year.

The formula

NOI = (gross rental income + other income - vacancy allowance) - operating expenses. Investors build it in layers: gross potential rent, then effective gross income after vacancies, then subtract the expenses needed to keep the building running. Every layer is a real decision point where sloppy assumptions hide.

What counts as income

Start with gross potential rent: the rent the property would collect in a full year at market rents with every unit occupied. Then add other income: laundry machines, parking fees, storage rentals, pet fees, late fees, vending. These line items are small individually and meaningful in total, and sellers sometimes bury them, so verify each one against the rent roll and bank statements.

The vacancy allowance

No property is full all year. Subtract a vacancy and collection allowance, typically 5% to 10% of gross rent depending on the market and tenant quality. This is one of the most abused inputs in a seller's pro forma: a 2% vacancy assumption on a building that historically runs 9% vacant inflates the NOI by thousands. Use the property's actual history, not the seller's optimism. The result after this step is effective gross income.

What counts as operating expenses

Subtract the costs of operating the building: property taxes, hazard and liability insurance, repairs and maintenance, property management fees, utilities the landlord pays, landscaping, and HOA dues if any. These are the expenses that exist no matter who owns the building. That is the whole point of NOI: it describes the property, not the buyer.

What stays out, and why

Four things are deliberately excluded. Mortgage payments stay out because financing is the buyer's choice, not the property's performance; two buyers with different down payments would otherwise get different NOIs for the same building. Income taxes stay out because every buyer is in a different tax situation. Depreciation stays out because it is a paper expense, not cash out the door. Capital expenditures (a new roof, a full repipe) stay out of NOI because they are irregular investments, not routine operating costs, though smart buyers budget for them separately. Debt service enters the picture later, when you calculate cash on cash return.

Worked example: a 4-unit building

Each of the four units rents for $1,200 a month, so gross potential rent is 4 x $1,200 x 12 = $57,600. Apply a 5% vacancy and collection allowance ($2,880) to get effective gross income of $54,720. Add $1,200 of laundry and parking income for total income of $55,920.

Operating expenses: property taxes $6,000, insurance $2,400, maintenance $4,800, management at 8% of effective income ($4,377.60), and landlord-paid utilities $1,800. Total: $19,377.60.

NOI = $55,920 - $19,377.60 = $36,542.40 per year. On a $500,000 purchase price, that is a 7.31% cap rate. If you own a building already, run your own numbers through our free cap rate calculator and compare.

Common NOI mistakes

The classic errors all inflate the number. Sellers forget the vacancy allowance, omit management fees because they self-manage (the next buyer will not), list only this year's low maintenance spend as the norm, and count one-time income like a lease-break fee as recurring. On the expense side, the most missed item is reserves: NOI ignores future capital spending, so a building with a 25-year-old roof and a healthy-looking NOI can still be a money pit. Always ask what the NOI looks like after a realistic repair budget.

Turn your NOI into a cap rate

Once you have the NOI, the next step is one division: our free calculator turns your income and price into a cap rate, monthly NOI, and price-to-income multiple in seconds.

Try the free cap rate calculator

Net operating income questions

What is net operating income in simple terms?

Net operating income is what a rental property earns in a year after paying its operating expenses, before the mortgage, income taxes, and depreciation. Start with all rental and other income, subtract vacancies and expenses like taxes, insurance, maintenance, and management, and the result is the NOI.

Is the mortgage included in NOI?

No. Mortgage principal and interest are excluded from net operating income on purpose, so the number describes the property rather than the buyer's financing. Debt service comes out later, when you calculate cash flow and cash-on-cash return.

What expenses are subtracted to get NOI?

Property taxes, insurance, repairs and maintenance, property management fees, utilities the landlord pays, and a vacancy allowance. Income includes rent plus other sources such as laundry, parking, and late fees. Excluded: mortgage payments, income taxes, depreciation, and one-time capital improvements.

How do you calculate NOI from rent?

Start with gross potential rent, subtract a vacancy and collection allowance to get effective gross income, add other income, then subtract operating expenses. Example: $57,600 of rent with a 5% vacancy allowance gives $54,720 effective income; after $1,200 of other income and $19,377.60 of expenses, the NOI is $36,542.40.

Can NOI be negative?

Yes, when operating expenses exceed income, usually from high vacancies, major repairs, or overestimated rents. A negative NOI means the property costs money to hold before the mortgage is even paid, and the cap rate formula breaks down, which is a strong signal to recheck every input.