What Is NOI (Net Operating Income)?
Net Operating Income (NOI) is a property's total revenue minus its operating expenses, excluding debt service, capital expenditures, and depreciation. It measures how much income a property generates from operations alone, making it the foundation of commercial real estate valuation.
// NOI Formula
NOI = Effective Gross Income - Operating Expenses
// Expanded
NOI = (GPR - Vacancy - Concessions + Other Income) - OpEx
What Is Included in NOI?
NOI includes all income the property produces and all expenses required to operate it on a day-to-day basis. Revenue items flow in from rent and ancillary sources, while operating expenses cover the recurring costs of keeping the property functional.
Revenue (included)
- Rental income (base rent)
- Parking fees
- Laundry and vending income
- Pet rent and pet deposits (non-refundable)
- Application and late fees
- Storage unit income
- RUBS (utility reimbursements)
Operating Expenses (included)
- Property taxes
- Insurance
- Utilities (owner-paid)
- Repairs and maintenance
- Property management fees
- Administrative costs
- Landscaping, pest control, trash
What Is Excluded from NOI?
NOI excludes any cost tied to financing, ownership structure, or long-term capital investment. These items vary by buyer and deal structure, so stripping them out lets investors compare properties on an apples-to-apples operating basis.
- Debt service: mortgage principal and interest payments
- Capital expenditures: roof replacements, HVAC systems, unit renovations
- Depreciation and amortization: accounting entries, not cash expenses
- Income taxes: vary by entity structure and investor
- Tenant improvements: leasing costs in commercial deals
- Leasing commissions: one-time costs, not recurring operations
The IRS Publication 527 provides detailed guidance on which rental property expenses are deductible. While tax deductions and NOI exclusions are not identical, understanding both helps ensure accurate underwriting.
How Does NOI Compare to Cash Flow and EBITDA?
NOI, cash flow, and EBITDA each measure profitability at a different level. NOI captures property operations. Cash flow accounts for financing. EBITDA spans an entire business.
| Metric | Starts With | Subtracts | Use Case |
|---|---|---|---|
| NOI | Effective Gross Income | Operating expenses only | Property valuation, cap rate calculation |
| Cash Flow (BTCF) | NOI | Debt service, capex reserves | Investor distributions, DSCR analysis |
| EBITDA | Total revenue | All operating expenses (company-wide) | Corporate valuation, REITs |
Why Does NOI Matter in Underwriting?
NOI is the single most important number in a commercial real estate deal because every other valuation metric depends on it. Cap rates, debt service coverage ratios, and cash-on-cash returns all start with NOI.
Lenders use NOI to size loans. Appraisers use NOI to set property values. Investors use NOI to compare deals across markets. A $50,000 error in NOI at a 5% cap rate means a $1,000,000 swing in property value.
The NAA Income/Expense Survey publishes annual benchmarks for operating expense ratios across U.S. multifamily markets. Comparing a property's expense ratio to these benchmarks is one of the fastest ways to spot underwriting errors.
What Are Common NOI Mistakes?
The most frequent error is including debt service in operating expenses, which double-counts financing costs and understates NOI. Other common mistakes include the following.
- Mixing capital expenditures with repairs and maintenance
- Using owner-reported expenses that include personal items (cell phone, vehicle, travel)
- Forgetting to normalize property management fees when the owner self-manages
- Using asking rents instead of in-place rents for the revenue line
- Ignoring loss to lease when projecting stabilized NOI
Pulling NOI from a T12 operating statement is standard practice. When a T12 is incomplete or contains non-recurring items, analysts adjust to a "normalized" or "stabilized" NOI that reflects typical operations. Use a pro forma template to ensure consistency.