Net Operating Income (NOI) is a fundamental financial metric in real estate that indicates how much profit a property generates from its core operations before accounting for financing costs or taxes. It is widely used by investors, lenders, and analysts to evaluate a property’s income-generating potential and overall financial health.
NOI is calculated by subtracting operating expenses from the sum of gross rental income and any additional income the property generates, such as fees from parking or laundry facilities. Operating expenses typically include property taxes, insurance, maintenance, utilities (if paid by the owner), property management fees, and marketing costs.
The standard formula for NOI is:
NOI = Gross Rental Income + Other Income – Operating Expenses
For example, if a building earns $150,000 in rent and $5,000 in other income annually, with operating expenses totaling $43,000, the NOI would be $112,000.
It’s important to note what NOI does not include: mortgage payments (principal and interest), depreciation, capital expenditures (large upgrades or replacements), and income taxes. Excluding these ensures that NOI measures the property’s operational earnings independent of financing or ownership tax situations.
NOI serves several crucial purposes:
• Property Valuation: Investors use it alongside the capitalization rate to estimate property value.
• Performance Assessment: It indicates how well a property is managed and how efficiently it generates income.
• Loan Underwriting: Lenders assess NOI to ensure the property produces sufficient income to cover operating costs and debt.
• Investment Comparison: NOI provides a financing-neutral way to compare profitability across properties.
Real estate investors should also consider vacancy rates by calculating effective gross income to reflect realistic occupancy, enhancing the accuracy of NOI calculations.
Understanding NOI helps investors make informed decisions by focusing on operational cash flow, providing a clear picture of a property’s income potential before financing and taxes. For further details about real estate loans and expenses related to operating properties, see Commercial Real Estate Loan and Expenses for Business Use of Your Home (Form 8829).
For official guidance, refer to IRS resources on rental income and expenses such as IRS Publication 527 (Residential Rental Property).
