What Is Net Operating Income (NOI)? The Number Behind Every Rental Valuation

Net operating income, or NOI, is the money a rental property earns in a year after paying to run it and before paying to finance it. Rent and other income come in. Vacancy, taxes, insurance, repairs, reserves and management go out. What remains is NOI.

It is the most used number in income property because it describes the building, not the buyer. The mortgage depends on who is buying and how much they put down. NOI does not. That is why appraisers value on it, lenders underwrite on it, and cap rates are quoted against it.

The definition in one line

NOI equals effective gross income minus operating expenses.

Effective gross income is the rent you collect, not the rent you schedule. Start with every unit at full rent, add parking, laundry, storage and pet fees, then subtract an allowance for empty months and unpaid rent. Operating expenses are every cost of keeping the property rented and standing. The NOI formula guide walks through each line in order.

Three things never appear in NOI: the mortgage, depreciation and income tax. They belong to the owner, not the property.

A worked example

Take a $300,000 house renting for $2,500 a month. Property taxes are $3,600 a year and insurance is $1,500. Allow 5% for vacancy, and set aside 18% of collected rent for maintenance (5%), capital reserves (5%) and management (8%).

Line	Amount
Gross scheduled income ($2,500 x 12)	$30,000
Vacancy at 5%	($1,500)
Effective gross income	$28,500
Property taxes	($3,600)
Insurance	($1,500)
Maintenance, reserves, management at 18% of $28,500	($5,130)
Total operating expenses	($10,230)
Net operating income	$18,270

That is $1,522.50 a month. Expenses take 35.9% of collected income, which is normal for a single-family rental in a state with property taxes around 1.2% of value. Run your own property through the calculator and it produces the same statement with your numbers.

Why NOI sets the price

Divide NOI by the price and you get the cap rate. On this house, $18,270 divided by $300,000 is 6.09%. Flip it around and NOI divided by the market cap rate gives value. If similar houses in the area sell at a 6.5% cap rate, $18,270 of NOI is worth $281,077, so the $300,000 asking price is about $19,000 above what the income supports.

This is how the income approach in an appraisal works, and it is why a small change in NOI moves the value so much. At a 6.5% cap rate, every extra $1,000 of NOI adds about $15,385 of value. A $50 rent increase, worth about $467 of NOI after vacancy and percentage expenses, adds roughly $7,200 to the price. The NOI and cap rate guide covers the math in both directions, and a Cap Rate Calculator will solve it for any property.

NOI for lenders

Commercial and small-balance lenders divide NOI by the annual loan payment to get the debt service coverage ratio. A 1.25 DSCR means NOI is 25% larger than the payment. On the house above, $18,270 of NOI supports annual debt service of about $14,616 at 1.25, which at 7% over 30 years is a loan of roughly $183,000. Ask for more and the lender either lowers the loan or asks for more NOI.

Residential DSCR lenders often simplify this to gross rent over the full payment, which is a different and more generous test. Know which one your lender uses before you count on a number.

NOI on a bigger property

The same statement scales. A 12-unit building at $1,100 a unit has gross scheduled income of $158,400. At 7% vacancy, $147,312 is collected. Suppose taxes are $22,000, insurance $9,500, owner-paid water and common electric $11,000, and 25% of collected income goes to repairs, reserves, management, payroll and leasing. Operating expenses total $79,328 and NOI is $67,984, an expense ratio of 54%.

That ratio is higher than the single-family house because the owner pays utilities and staff. It is not worse. A 12-unit building with a 36% expense ratio is either brand new or hiding something. The expense ratio guide gives ranges by property type.

What NOI leaves out

NOI stops before four things that matter to you as the owner.

Debt service. Same NOI, different loans, different cash flow. The NOI vs cash flow guide works through this.

Capital improvements. A new kitchen or an added unit is an investment, not an operating cost. Replacing a worn water heater is what the reserve line covers.

Depreciation and income tax. Those live on your Schedule E, not on the property’s operating statement.

Growth. NOI is one year. A property whose rents are 15% below market has more NOI coming, and a buyer who only looks at the trailing statement misses it.

Pro forma NOI versus actual NOI

A listing usually shows pro forma NOI: what the property could earn at market rent with the seller’s idea of expenses. Actual NOI is what it earned over the last twelve months. The gap between them is where deals go wrong.

Common pro forma habits: market rent on every unit including the three that have had the same tenant for eight years, no vacancy line, no management fee because the seller self-manages, no reserves, and last year’s property tax bill rather than the one you will get after the county reassesses on sale. Each of these adds one to three points to the cap rate. Rebuild the statement yourself. The operating expenses guide lists everything that belongs on it.

Reading NOI quickly

A few checks that catch most bad numbers.

Expense ratio. Under 30% on anything but a new build in a low-tax state means something is missing, usually management and reserves. Over 60% means either heavy owner-paid utilities or rent that is well under market.

Taxes. Look up the county’s reassessment rules. In states that reassess on sale, taxes on a $300,000 purchase can be double what the seller paid.

Vacancy. Zero is not a forecast. Use 5% for stable long-term rentals and 8 to 10% for higher-turnover units.

NOI per unit. Divide by the unit count. Two buildings with the same total NOI and different unit counts are not the same investment, because more units means more turnover, more repairs and more management time per dollar of income.

Once the statement holds up, NOI becomes the anchor for everything else: the price you can pay at a given cap rate, the loan the property supports, and the cash flow you will see after the payment. See what $25,000 of NOI is worth at each cap rate on the $25k NOI page, or what a rental at each price typically produces on the $300k price page.