What Is NOI in Real Estate

What is NOI in real estate? Net operating income is the rent and other property income left after vacancy and operating expenses. Debt service stays off this line. So does depreciation. So does the cash from a loan. NOI is the property’s operating result for a period, usually a year. Buyers, sellers, and financing reviews all start here because the number can be built from a rent roll and a stack of bills.

These figures are an illustration. They are not a rate quote, an offer of credit, or a prediction of profit. An inquiry is not an approval.

What Is NOI in Real Estate After Vacancy and Expenses

Say the formula in one pass. Start with gross potential rent. Subtract vacancy and credit loss. Add other property income you actually earn. Subtract operating expenses. The remainder is NOI.

Gross potential rent is the rent you would collect if every unit stayed occupied at the rent you are underwriting. A house leased at $2,200 a month has gross potential rent of $26,400. One empty month is $2,200 of vacancy. Effective rental income is $24,200. In this illustration there is no parking, laundry, or pet rent, so other income is zero.

Operating expenses in the same illustration:

• Property tax: $3,200
• Landlord insurance: $1,600
• Repairs and turns: $1,400
• Management: 8 percent of effective rent, or $1,936
• Admin and bookkeeping: $200
• Replacement reserve: $1,200

Those bills sum to $9,536. Effective rent of $24,200 minus $9,536 leaves NOI of $14,664. That is the base case for this page.

Line	Annual amount
Gross potential rent	$26,400
Less vacancy	$2,200
Effective rent	$24,200
Less operating expenses, including the reserve	$9,536
NOI	$14,664

The 8 percent management line is an illustration, not a fee quote. What property managers charge is a separate question. If you manage the house yourself, you can leave the fee at zero and accept that your time is unpaid, or you can insert a fee so this house can be compared with one you will not self-manage. Write down which choice you made.

Drop the reserve and NOI rises to $15,864. A lender file often keeps a reserve inside the expenses, because roofs and heaters fail on a calendar the lease does not control. A reserve of $1,200 will not fund a roof. It will stop you from treating every quiet month as spendable. If you omit it, say so next to the NOI.

Income That Belongs on the Top Line

Use the lease, then stress it. A renewal can make vacancy zero for a long stretch. A turnover can cost a month of rent plus paint and a week of lost days. Write the vacancy you believe, and write a worse one beside it. The national vacancy rate describes the housing stock. Your door is one lease.

IRS Topic 414 says cash, or the fair market value of property or services you receive for the use of real estate, is rental income. A security deposit you may have to return is not income. If you later keep part of it because the tenant broke the lease, the amount you keep is income when you keep it. If you keep it because of damage and your practice is to deduct the repairs, Topic 414 says you include the amount you keep. Advance rent is income when you receive it, including a deposit that is really the last month’s rent. For NOI, a refundable deposit stays out of income. Prepaid rent comes in. Label the cash before it hits the top line.

Tenant-paid utilities stay out of both income and expenses when the tenant pays the provider directly. If the tenant pays your water bill and you would otherwise have paid it, Topic 414 treats that payment as rental income, and you may still deduct the expense if it is deductible. Put the same dollars on both sides or on neither side. Do both, or do neither.

Bills That Belong in Operating Expenses

Operating expenses are the costs of keeping the property rented and standing. Taxes, insurance, routine repairs, utilities the owner pays, management, lawn care, admin, and often a replacement reserve belong here.

A few items investors mix into this list sit somewhere else:

• The loan payment, principal and interest, comes after NOI.
• A cash-out refinance deposits loan proceeds. That cash is borrowing. It does not raise NOI.
• Depreciation is a tax deduction. No check is written for it in the operating month. Leave it out of NOI. How the deduction works is covered in how depreciation works on a rental.
• A new roof or a full kitchen rebuild is a capital improvement. It may raise future rent. The invoice itself is not an operating expense. The repair-versus-improvement test is on its own page.
• Income tax on your return is personal to you. NOI is a property figure before that tax.

Escrow does not erase tax and insurance. When the servicer drafts them with the payment, they are still operating costs. Count them in the expense list. If your “payment” already includes them, pull them back out of debt service so you do not subtract them twice.

A flat percent of rent is a screen, not this statement. Build the list from the tax bill, the policy, and the repair history. Then you can audit the NOI.

What Happens After NOI

Cash flow continues one line past NOI. Subtract debt service, the full principal-and-interest payment, from NOI. With NOI of $14,664 and an illustrated payment of $12,000, cash left after debt service is $2,664. That leftover is cash flow. The steps live on how to calculate rental property cash flow.

Coverage is a ratio, not a dollar result. Divide the $14,664 by the $12,000 payment and you get about 1.22. That idea is the debt service coverage ratio for a rental. Programs differ on the coverage they look for. A ratio above 1.00 means this NOI cleared this payment. It does not promise that a financing review will use your vacancy, your reserve, or your management fee.

Divide NOI by price and you have a cap rate. At a $280,000 price, $14,664 is about 5.2 percent. Cap rate versus cash-on-cash separates that unlevered yield from the yield on the cash you put in. The cap rate uses NOI. It ignores the loan. Change the reserve and you change the cap rate, even though the tenant paid the same rent.

A commercial loan file often rebuilds this statement from a trailing twelve months, a rent roll, and a reserve the reviewer chooses. How to calculate NOI for a commercial loan is that version. The arithmetic on this page is the same skeleton. The inputs a reviewer will accept can be tighter than the inputs you hope for.

Stress the Vacancy Before You Trust the Number

Run the house with two empty months. Vacancy becomes $4,400. Effective rent falls to $22,000. Management at 8 percent falls to $1,760. Operating expenses become $9,360. NOI falls to $12,640.

Against the same $12,000 payment, cash left after debt service is $640. The property still clears the payment in this illustration. The cushion is thin. One water-heater call can consume it. That is the point of building NOI before you talk about the loan. The payment does not shrink because the unit sat empty.

Breakeven occupancy asks the question from the other direction: what share of potential rent must come in before expenses and debt service are covered. NOI tells you the dollars at a vacancy you chose. Breakeven occupancy tells you how full the building must be.

A value-add plan is a second NOI, built from rents and expenses you have not achieved yet. Keep the in-place NOI and the plan NOI in separate columns. Value-add investing is the work of moving the property from the first column toward the second while you hold it.

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Frequently Asked Questions

Does NOI include the mortgage payment?

NOI stops before debt service. The principal-and-interest payment is the next subtraction, and the result of that subtraction is cash flow. Taxes and insurance stay inside operating expenses even when the servicer collects them with the payment. Count those two costs once.

Are loan proceeds part of NOI?

Loan proceeds are borrowed cash. A refinance can put money in your account and leave the rent roll unchanged. NOI moves when income or operating expenses move. The new loan shows up later, as debt service, and at a sale, as a payoff.

Should a replacement reserve be inside NOI?

Many loan files deduct a reserve so NOI is not a best case that assumes nothing large breaks. An owner statement sometimes shows the reserve below NOI. Either presentation can be honest if you label it. Compare two properties only when both treat the reserve the same way.

Is NOI the same as taxable rental income?

Taxable rental income starts from rent and then subtracts deductible expenses, including depreciation and, in many cases, mortgage interest. NOI leaves depreciation out and leaves the entire loan payment out. The bank balance, the NOI, and the number on the tax return can all differ in the same year. Topic 414 is about income and deductions. NOI is about operations before debt.

Can NOI be negative?

Yes. If vacancy and operating expenses exceed the rent and other property income, NOI is negative. The loan payment then has to be covered from reserves or from money outside the property. A negative NOI is a fact about the period you measured. A financing review is a separate look at that fact.