Formula
NOI = Effective Gross Income − Operating Expenses
Source: Fannie Mae Multifamily Selling and Servicing Guide (opens in a new tab), Glossary, “Net Operating Income”
- Effective Gross Income
- Gross potential rent less loss to lease, vacancy and collection loss, and concessions, plus other income.
- Operating Expenses
- Costs of running the property: taxes, insurance, utilities, repairs, management and payroll.
How it works
NOI matters because it is the input to everything else. Value is NOI divided by a cap rate. DSCR is NOI divided by debt service. Debt yield is NOI divided by the loan. An error in NOI does not stay contained: it propagates into the valuation, the loan size and the return, multiplied by the reciprocal of a cap rate. At a 6% cap rate, a $10,000 mistake in NOI is a $167,000 mistake in value.
What is excluded is as important as what is included. Debt service is excluded because NOI describes the property, not the financing: two buyers with different loans produce the same NOI on the same building. Capital expenditure is excluded because it is lumpy and discretionary in timing, though most underwriters approximate it with a normalized replacement reserve, deducted below NOI to reach net cash flow. Depreciation is excluded because it is an accounting allocation rather than a cash cost, and income tax is excluded because it depends on the owner's circumstances.
The gap between a seller's NOI and an underwriter's NOI is where most of the negotiation in a commercial transaction actually happens. Sellers present NOI built on stabilized assumptions: full occupancy, no management fee because they self-manage, and one-off items excluded selectively. Underwriters normalize all of it: marking vacancy to market, adding a management fee whether or not it is paid, and removing non-recurring income. The difference is routinely 5% to 15% of the reported figure.
NOI is also the reason lease structure matters so much. Under a triple-net lease the tenant pays taxes, insurance and maintenance directly, so operating expenses at the property level are minimal and NOI sits close to gross rent. Under a gross lease the landlord absorbs those costs, and the same headline rent produces materially lower NOI. Comparing two properties on rent alone, without reference to lease structure, compares nothing at all.
Worked example
A 60-unit apartment property has gross potential rent of $900,000. Market vacancy and collection loss is 6%. Other income (parking, laundry, pet fees) is $40,000. Leases are at market and no concessions are offered, so loss to lease and concessions are zero. The seller reports operating expenses of $310,000 but self-manages and carries no replacement reserve.
| Step | Calculation | Result |
|---|---|---|
| Deduct vacancy and collection loss | $900,000 × 6% | −$54,000 |
| Compute effective gross income | $900,000 − $54,000 + $40,000 | $886,000 |
| Add a market management fee at 4% of EGI | $886,000 × 4% | +$35,440 of expense |
| Compute underwritten operating expenses | $310,000 + $35,440 | $345,440 |
| Compute underwritten NOI | $886,000 − $345,440 | $540,560 |
| Below NOI, deduct a replacement reserve at $300 per unit | $540,560 − 60 × $300 | $522,560 net cash flow |
The seller would present NOI of $576,000: effective gross income less the reported $310,000 of expenses. The underwritten NOI is $540,560, some 6.2% lower, and the entire difference is a management fee the seller did not incur but the next owner will. At a 6% cap rate that $35,440 gap is $590,667 of value. A lender then deducts the $18,000 reserve below NOI and tests coverage on net cash flow of $522,560. No tenant moved and no rent changed; the difference is entirely a matter of how the income statement was normalized.
Typical ranges
| Property type | Typical expense ratio | Driver |
|---|---|---|
| Multifamily | 35% – 50% | Payroll, turnover and utilities carried by the landlord. |
| Office, gross lease | 40% – 50% | Landlord absorbs taxes, insurance, utilities and janitorial. |
| Retail, triple-net | 5% – 15% | Tenant pays most operating costs directly. |
| Industrial, triple-net | 5% – 15% | Minimal landlord responsibility beyond structure and roof. |
| Hospitality | 65% – 80% | An operating business, not a passive lease. |
Common mistakes
- Accepting the seller's NOI without normalizing
- Self-managed properties carry no management fee, which is a real cost to the next owner.
- Deducting debt service or depreciation
- NOI describes the property independent of financing and tax position. Deducting either makes the figure incomparable to any other property.
- Including one-time income such as a lease termination fee
- Non-recurring income capitalized at a market cap rate creates value that does not exist.
- Using in-place rents when leases are expiring imminently
- A rent roll is a snapshot. Income from a lease that expires in four months is not durable income, and underwriters mark it to market.
Frequently asked questions
- What is included in net operating income?
- Gross potential rent less loss to lease, vacancy and collection loss, and concessions, plus other property income, less operating expenses such as property taxes, insurance, utilities, repairs and maintenance, management fees and payroll. Debt service, capital expenditure, depreciation and income tax are all excluded.
- Does NOI include mortgage payments?
- No. NOI is calculated before debt service, precisely so that it describes the property rather than the owner's financing. Two buyers with different loans compute the same NOI for the same building.
- What is the difference between NOI and cash flow?
- NOI is income after operating expenses but before financing and capital costs. Cash flow after debt service deducts loan payments, and cash flow after capital items further deducts capital expenditure, tenant improvements and leasing commissions. Each step down produces a smaller and more owner-specific number.