Glossary
Net Operating Income (NOI)
Net operating income (NOI) is the income a property generates after operating expenses but before debt service, income taxes, depreciation and capital expenditures. It equals effective gross income minus operating expenses and is the starting point for cap rate valuation, DSCR and debt yield.
Formula
Example
A retail center has gross potential rent of $1,200,000. Vacancy and credit loss of 8% removes $96,000, and other income adds $36,000, so effective gross income is $1,140,000. Operating expenses of $440,000, including taxes, insurance, repairs and management, leave NOI = $1,140,000 - $440,000 = $700,000. Mortgage payments, depreciation, income taxes and capital improvements are not deducted.
How it is used in underwriting
NOI is the single most important number in income property underwriting because nearly every other metric depends on it. Appraisers divide it by a cap rate to estimate value, lenders divide it by debt service to get DSCR and by the loan amount to get debt yield, and investors use it to project cash flow and returns. Underwriters typically build NOI from the trailing twelve month operating statement and rent roll, then adjust it to reflect market vacancy, a market management fee, normalized repairs and a replacement reserve, so the figure represents sustainable performance rather than a single year's results.
The most common NOI errors come from inconsistent definitions. Sellers may present NOI before management fees or reserves, exclude a pending tax reassessment, or annualize a strong recent month. Lenders often deduct reserves for replacements, tenant improvements and leasing commissions to reach underwritten net cash flow, which is lower than NOI. Real estate NOI is similar to EBITDA for operating businesses, but it excludes corporate overhead and is tied to a specific property. Always confirm which version you are looking at before comparing NOI across deals or applying a market cap rate.
Run the numbers: NOI Calculator
Frequently asked questions
Does NOI include mortgage payments?
No. NOI is calculated before debt service, so mortgage principal and interest are excluded. This keeps NOI independent of how a property is financed, which is why it can be used to value the asset and to compare properties with different capital structures. Cash flow after debt service is a separate figure.
Are capital expenditures included in NOI?
Capital expenditures such as roof replacements or major renovations are generally excluded from NOI. However, lenders and many investors deduct a recurring replacement reserve when underwriting, and some include reserves for tenant improvements and leasing commissions, producing a net cash flow figure that is lower than reported NOI.
What is the difference between NOI and cash flow?
NOI measures property income after operating expenses but before financing and capital costs. Cash flow, often called cash flow before tax, subtracts debt service and capital expenditures from NOI. Two identical properties can have the same NOI but very different cash flow if one carries a large loan.
Related terms
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