Net Operating Income (NOI)

Net operating income (NOI) is a measure of the profitability of an income-producing property, such as an apartment building, office, shopping center or warehouse. It equals the revenue the property generates, mainly rent, minus the costs of operating it, such as property taxes, insurance, maintenance, utilities and management fees. NOI deliberately leaves out financing costs, depreciation, capital expenditures and the owner's income taxes, so that it reflects the performance of the property itself regardless of who owns it or how it was financed.

NOI is the central figure in real estate valuation and lending. In general corporate finance, the term is sometimes used loosely for operating income on a company's income statement, but in most professional usage it refers to property-level income. It is not a GAAP measure, so its exact definition can vary between owners and should be checked.

The calculation starts with potential rent and works down:

• $\text{Effective gross income}$ is potential gross rent, less vacancy and collection losses, plus other income such as parking, laundry and service charges. The entry on effective gross income explains this step.
• $\text{Operating expenses}$ are the recurring costs of running the property: property taxes, insurance, repairs and maintenance, utilities paid by the owner, management fees, cleaning, security and landscaping.

Items excluded from operating expenses include mortgage principal and interest, depreciation, major capital improvements, leasing commissions and tenant improvement costs (often deducted separately below NOI), and income taxes.

A 40-unit apartment building could earn $720,000 a year if fully let. The owner expects a 5 percent vacancy rate, a loss of $36,000, and earns $14,000 from parking and laundry. Effective gross income is $698,000. Operating expenses are property taxes $92,000, insurance $28,000, repairs and maintenance $64,000, utilities $40,000, management fees at 5 percent of collections $34,900, and other costs $19,100, a total of $278,000. NOI is $698,000 minus $278,000, or $420,000.

If similar buildings in the area sell at a capitalization rate of 6 percent, the building's estimated value is $420,000 divided by 0.06, or $7,000,000. If the owner's annual mortgage payments are $320,000, the debt service coverage ratio (DSCR) is $420,000 divided by $320,000, or about 1.31, which many lenders would consider acceptable.

• Valuation: dividing NOI by a market capitalization rate gives a quick estimate of value, and small changes in NOI have a large effect on that value.
• Lending: banks size commercial mortgages based on NOI, typically requiring a minimum debt service coverage ratio and a maximum loan-to-value ratio.
• Performance tracking: owners compare NOI over time and against budgets, often on a "same-store" basis that excludes properties bought or sold.
• Investor reporting: a real estate investment trust (REIT) commonly reports NOI as a supplementary non-GAAP measure alongside funds from operations.

Because NOI excludes capital spending, a property that needs a new roof or lifts can look more profitable than it really is; analysts therefore often deduct a reserve for replacements. Sellers may present NOI using optimistic rent assumptions, unrealistically low vacancy or deferred maintenance, so buyers recalculate it from rent rolls and expense records. NOI also ignores the cost of borrowing, so two identical buildings have the same NOI even if one is heavily mortgaged; the difference shows up in cash flow after debt service. Finally, NOI differs from EBITDA, a company-level measure that includes corporate overheads, and from net income, which is after interest, depreciation and tax.