What is NOI (Net Operating Income)?
Net operating income (NOI) is the total income generated by a rental property after subtracting all operating expenses but before deducting mortgage payments, capital expenditures, and income taxes. NOI is the foundation metric for rental property analysis -- it feeds directly into cap rate calculations and is the starting point for evaluating whether a property produces enough income to justify its price.
NOI = Gross Operating Income - Operating Expenses
Gross Operating Income = Gross Potential Rent - Vacancy Allowance + Other Income
The critical point about NOI: it does not include mortgage payments. This is intentional. NOI measures the property's earning power independent of how it's financed. Two investors might buy the same property with different loan terms, but the NOI is identical because it reflects the property itself, not the financing structure.
Calculating NOI step by step
Income side
- Gross potential rent: Total annual rent if the property were 100% occupied. For a single-family rental at $1,500/month, that's $18,000.
- Vacancy allowance: Budget for periods when the unit is empty between tenants. Typically 5-8% of gross rent. Subtract this from gross rent.
- Other income: Late fees, pet fees, laundry income, parking fees, storage rental. Add these to get Gross Operating Income.
Expense side
- Property taxes: Annual tax bill. The largest single expense in most cases.
- Insurance: Landlord policy (not homeowner's -- different and usually more expensive).
- Property management: 8-10% of collected rent for professional management, or budget 5% for self-management (your time has value).
- Maintenance and repairs: Budget 5-10% of gross rent for routine maintenance, repairs, and turnover costs.
- HOA fees: If applicable. Condos and townhomes often have significant monthly HOA dues.
- Utilities: Only include utilities the landlord pays (water, trash, lawn care in some cases). Tenant-paid utilities are not your expense.
What's NOT in NOI
- Mortgage payments (principal or interest)
- Capital expenditures (roof replacement, HVAC, major renovations)
- Income taxes (investor's personal tax obligation)
- Depreciation (an accounting concept, not a cash expense)
NOI example
| Item | Annual |
|---|---|
| Gross potential rent ($1,500 x 12) | $18,000 |
| Vacancy (5%) | -$900 |
| Other income (pet fee) | +$600 |
| Gross Operating Income | $17,700 |
| Property taxes | -$3,500 |
| Insurance | -$1,200 |
| Management (8%) | -$1,416 |
| Maintenance (5%) | -$885 |
| NOI | $10,699 |
How investors use NOI
NOI is the building block for the most important rental analysis metrics. Divide NOI by property value to get the cap rate. Subtract mortgage payments from NOI to get pre-tax cash flow. Compare NOI across properties to see which generates more income relative to price. Estimate property value by dividing NOI by the prevailing cap rate in the market.
When marketing a rental deal to investors, presenting a clear NOI breakdown gives buyers confidence in the numbers. A well-documented NOI with realistic expense assumptions is far more convincing than "the rent is $1,500 a month" without any context on expenses.