How net operating income works
By Jude Wallis
Net operating income is what a property earns before any financing. Take $48,000 of gross rent, subtract $2,400 of vacancy to get $45,600 of effective gross income, then subtract $9,600 of operating expenses. NOI is $36,000, and no mortgage payment appears anywhere in it.
Net operating income
$36,000.00
Gross rent minus vacancy minus operating expenses, before debt service.
- Gross rent
- $48,000.00
- Effective gross income
- $45,600.00
- NOI
- $36,000.00
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In short
- Two subtractions in order: $48,000 minus $2,400 is $45,600, minus $9,600 is $36,000.
- Mortgage payments, depreciation and income tax are all excluded on purpose.
- That exclusion is what makes two properties comparable regardless of how each was financed.
- A property collecting $60,000 with $3,000 of vacancy and $15,000 of costs earns $42,000, on a much heavier expense load.
- NOI is the numerator of both the cap rate and the debt service coverage ratio.
Effective gross income comes first
Gross rent is the rent roll if every unit is let every month, which never happens. Subtracting a vacancy allowance gives effective gross income, and on this property $48,000 less $2,400 is $45,600.
That allowance is an estimate, and it is the first place an optimistic model hides. A 5 percent assumption in a market that runs at 10 percent will overstate NOI, the cap rate and the coverage ratio simultaneously, since all three are built on the same figure.
What counts as an operating expense
Property taxes, insurance, management fees, repairs, utilities the landlord pays and routine maintenance are operating expenses. Mortgage interest is not. Principal repayment is not. Depreciation is not, because it is an accounting entry rather than cash. Capital improvements are not, because they buy a new asset rather than run the existing one.
On this property those operating costs come to $9,600, taking $45,600 down to $36,000. Get the boundary wrong in either direction and every ratio built on NOI moves with it.
Why financing is deliberately left out
Two buyers can pay the same price for the same building and finance it completely differently. If NOI included the mortgage, the same property would have two different NOIs, and comparing it with anything else would be impossible.
Leaving financing out is what lets NOI feed a cap rate, which compares properties, and a coverage ratio, which compares income with a specific loan. Cap rate against DSCR shows the two uses side by side, and NOI against cash flow shows what happens once the loan does enter the picture.
Reading it as an owner
NOI is a property measure, so treating it as spendable money is the error to avoid: the mortgage and capital spending both come out of it before anything reaches you. Read it alongside the rental cash flow calculator, which carries the chain through to what actually lands, and the DSCR calculator, which tests it against the loan. The NOI calculator runs the two subtractions in order. This is educational material, not financial advice.
Worked examples
\$48,000 of rent with \$9,600 of costs
A rental collects $48,000 of gross rent a year, allows $2,400 for vacancy and spends $9,600 on operating expenses. What is NOI?
- Effective gross income is 48,000 minus 2,400, which is $45,600.
- NOI is 45,600 minus 9,600, which is $36,000.
Net operating income is $36,000, before any mortgage payment.
A heavier expense load
A second property collects $60,000 of gross rent, allows $3,000 for vacancy and spends $15,000 on operating costs.
- Effective gross income is $57,000.
- NOI is 57,000 minus 15,000, which is $42,000.
$42,000. It collects 25 percent more rent than the first property but keeps a smaller share of it.
Common questions
Does NOI include the mortgage?
No. Excluding financing is the definition, and it is what makes the figure comparable across properties.
Should a capital reserve be deducted?
Not inside the standard definition. Many investors subtract one separately so NOI is not mistaken for spendable cash.
Is depreciation an operating expense?
No. It is an accounting allocation, not a cash cost, so it sits outside NOI.
Is this financial advice?
No. It is educational material about a property income measure.
Keep reading
This page is educational material, not financial advice. The figures come from the formula shown and assume the inputs you enter hold for the whole term. Your own rate, fees, taxes and timing will differ, so treat the output as arithmetic to check a decision against, not as a recommendation.