What Is Net Operating Income?

Net Operating Income is the single most important number in rental property investing. It tells you how much money a property actually makes from operations, before you factor in financing. Every other metric builds on NOI. Cap rate, debt service coverage ratio, property valuation. They all start with NOI.

If you only learn one formula as a landlord, make it this one.

How to Calculate NOI

NOI = Effective Gross Income - Operating Expenses

Let's break that down.

Effective Gross Income is all the money the property brings in. That includes rent, late fees, parking fees, laundry income, pet fees, anything. Then subtract vacancy and credit losses (tenants who do not pay).

Operating Expenses are the costs of running the property. Property taxes, insurance, repairs, maintenance, property management fees, utilities you pay, landscaping, and administrative costs.

What is NOT included in operating expenses: mortgage payments (principal and interest), capital expenditures (roof replacement, new HVAC), depreciation, and income taxes.

Real Example: 8-Unit Building NOI

Let's calculate NOI for a small apartment building.

Income:
8 units × $1,250/month = $120,000/year gross potential rent
Laundry income: $1,800/year
Late fees collected: $900/year
Gross Potential Income: $122,700

Less vacancy (5%): -$6,135
Effective Gross Income: $116,565

Operating Expenses:
Property taxes: $11,400
Insurance: $4,800
Repairs and maintenance: $8,400
Water/sewer/trash: $4,200
Common area electric: $1,800
Landscaping/snow: $2,400
Pest control: $960
Accounting/legal: $1,200
Total Operating Expenses: $35,160

NOI: $116,565 - $35,160 = $81,405

This building generates $81,405 per year in net operating income. That is $6,784 per month before mortgage payments. If the property is worth $900,000, the cap rate is 9.0% ($81,405 ÷ $900,000).

Why NOI Matters

Property valuation. Commercial and multifamily properties are valued based on NOI. If you increase your NOI by $5,000 per year in an 8% cap rate market, your property value just went up by $62,500 ($5,000 ÷ 0.08). That is the power of NOI for building wealth.

Loan qualification. Lenders use NOI to calculate the debt service coverage ratio (DSCR). If your NOI does not cover the mortgage payment by at least 1.2x, you will not get the loan.

Investment comparison. NOI normalizes the comparison between properties. A 20-unit building with $200,000 NOI and a 10-unit building with $100,000 NOI have the same per-unit NOI ($10,000). Now you can compare apples to apples.

How to Increase NOI

There are only two levers: increase income or decrease expenses.

Increase income:

• Raise rents to market rate (see rent increase)
• Reduce vacancy by improving tenant retention
• Add income sources: covered parking ($50-100/month per spot), pet rent ($25-50/month), storage units, laundry
• Enforce late fees consistently (see late fees)

Decrease expenses:

• Shop insurance annually (most landlords overpay by 10-20%)
• Appeal property taxes (especially after a down year)
• Switch to preventive maintenance to reduce emergency repair costs
• Self-manage instead of paying a property manager (saves 8-10% of gross rent)
• Install water-saving fixtures to cut utility costs

Common Mistakes With NOI Calculations

Including mortgage payments. This is the most common error. Your mortgage payment is NOT an operating expense. NOI measures the property's performance independent of how you financed it.

Forgetting vacancy. Even if your property is currently 100% occupied, you need to include a vacancy allowance of at least 5%. Tenants leave. It happens.

Underestimating maintenance. Budget at least 5-10% of gross rent for repairs and maintenance. New landlords often estimate 2-3% and get hammered when the water heater dies and two units need appliance replacements in the same month.

Mixing up NOI and cash flow. NOI is before debt service. Cash flow is after. If your NOI is $80,000 and your annual mortgage payment is $60,000, your cash flow is $20,000. Those are two very different numbers.

Using the seller's numbers. Always build your own NOI from scratch. Sellers understate expenses and overstate income. Get actual tax records, actual insurance quotes, and actual rent amounts from the rent roll.

Frequently Asked Questions

What is included in NOI?

All rental income minus operating expenses. Operating expenses include property taxes, insurance, maintenance, management fees, and utilities. NOI does NOT include mortgage payments, capital expenditures, depreciation, or income taxes.

What is a good NOI for rental property?

It depends on property size and value. Focus on the NOI margin (NOI ÷ gross income). A healthy margin is 50-70% for self-managed properties and 40-60% when paying for property management.

Is NOI the same as profit?

No. Profit (cash flow) is NOI minus mortgage payments. NOI measures the property's operational performance independent of financing. A property with great NOI can still have negative cash flow if it is overleveraged.