Understanding Net Operating Income (NOI) is one of the most important steps in learning how real estate investments work. Whether you want to buy your first rental property or you are simply trying to understand how investors measure performance, learning about NOI gives you a strong foundation.

In this simple yet detailed guide, you’ll learn what Net Operating Income is, how to calculate Net Operating Income, and why it matters in real estate. We will also explain common mistakes, real examples, and how NOI affects property value.

Let’s begin.

Table of Contents

What Is Net Operating Income (NOI)?

Net Operating Income is the amount of money a property earns after paying all operating expenses, but before paying taxes, mortgage payments, and other financial costs.

In other words, NOI tells you how much income the property itself is generating. It shows the true performance of the real estate investment.

Think of it this way:
If your property is a business, NOI shows how much profit the business makes from daily operations.

Why Is Net Operating Income Important?

Investors care about NOI because it shows the real health of a property. It helps them answer questions like:

Is the property profitable?
Will the investment produce reliable income?
Can the property cover its expenses?
What is the property’s fair market value?
Should I buy, sell, or hold the property?

Many real estate decisions depend on understanding NOI correctly.

Key Components of Net Operating Income

To understand how NOI works, you need to know what it includes and what it does not include.

1. Included in NOI (Operating Income and Expenses)

Operating income means all money the property earns, such as:

Rental income
Parking fees
Laundry machine income
Vending machine income
Storage fees
Service charges

Operating expenses include the cost of running the property, such as:

Property management fees
Repairs and maintenance
Utilities
Property insurance
Property taxes
Marketing expenses

These expenses are necessary to keep the property running.

2. Not Included in NOI (Non-Operating Costs)

Net Operating Income does not include:

Mortgage payments
Income taxes
Depreciation
Capital expenditures (large long-term improvements)
Loan fees
Personal expenses

These items do not affect day-to-day operations, so they are excluded.

How to Calculate Net Operating Income

The NOI formula is simple:

NOI = Gross Operating Income – Operating Expenses

Let’s break down each part.

Step 1: Calculate Gross Operating Income (GOI)

Gross Operating Income includes:

Potential rental income (if fully occupied)
Other income (parking, laundry, etc.)
Minus vacancy losses

Formula:

GOI = Potential Rental Income + Other Income – Vacancy Loss

Step 2: Subtract Operating Expenses

Once you know the GOI, subtract all operating expenses to get the NOI.

Net Operating Income Example

Let’s look at a simple example to make this very clear.

A small apartment building earns:

Potential rent per year: $200,000
Other income: $10,000
Vacancy loss: $15,000

Operating expenses:

Repairs: $8,000
Utilities: $10,000
Property taxes: $12,000
Insurance: $3,000
Maintenance: $5,000
Property management: $7,000

Step 1: Calculate GOI
GOI = $200,000 + $10,000 – $15,000
GOI = $195,000

Step 2: Calculate NOI
Total operating expenses = $8,000 + $10,000 + $12,000 + $3,000 + $5,000 + $7,000
Total expenses = $45,000

NOI = $195,000 – $45,000
NOI = $150,000

This means the property earns $150,000 from its operations.

Why Investors Care About Net Operating Income

1. Helps Determine Property Value

NOI is important for determining the market value of a property. Investors use a formula called the capitalization rate (cap rate):

Value = NOI / Cap Rate

So, if a property produces $150,000 NOI and the market cap rate is 6%, then:

Value = 150,000 / 0.06
Value = $2,500,000

This is why increasing NOI can increase the value of a property.

2. Measures Profitability

NOI is one of the best ways to measure how profitable a property is. Because it removes non-operating expenses, it shows the actual performance of the property itself.

3. Helps Compare Multiple Properties

Investors often compare NOI across different properties to decide which one is the best investment. A property with a higher NOI is usually more attractive.

4. Acts as a Foundation for Other Metrics

NOI is used to calculate important metrics like:

Debt Service Coverage Ratio (DSCR)
Return on Investment (ROI)
Cash-on-Cash Return

Without NOI, these calculations would be impossible.

Common Mistakes When Calculating NOI

Even professionals make mistakes when calculating Net Operating Income, so it’s important to avoid these errors.

1. Including Mortgage Payments

Many beginners mistakenly subtract mortgage or loan payments.
This is wrong.
Mortgage payments are not operating expenses.

2. Forgetting Vacancy Loss

Vacancy affects income. Ignoring it will give a fake number and make the property look more profitable than it really is.

3. Ignoring Capital Expenditures

Capital expenditures are big, long-term improvements like a new roof.
They should not be included in NOI.

4. Including Non-Property Income

If the owner earns money from another business on the same property, that extra income should not be counted.

What Affects Net Operating Income?

NOI can go up or down depending on several factors.

1. Rent Prices

Increasing rent, even slightly, can significantly boost NOI.

2. Occupancy Rates

Higher occupancy means more income.
Lower occupancy means smaller NOI.

3. Operating Expenses

If expenses go up, NOI goes down.
If expenses go down, NOI improves.

4. Market Conditions

In strong markets, rents usually rise, increasing NOI.
In weak markets, vacancy rises, decreasing NOI.

5. Property Management Quality

Good management can reduce costs and improve income.

Ways to Improve Net Operating Income

If a property has a low NOI, there are several strategies to increase it.

1. Increase Rent Carefully

Raising rent slightly can dramatically increase NOI without hurting occupancy.

2. Add New Income Streams

These may include:

Parking fees
Laundry machines
Storage units
Pet fees
Vending machines

These small additions can add up.

3. Reduce Operating Expenses

Find ways to cut costs, such as:

Energy-efficient lighting
Lower-cost vendors
Preventive maintenance
Water-saving fixtures

4. Improve Tenant Retention

Happy tenants stay longer.
Longer stay = fewer vacancies = higher NOI.

Difference Between NOI and Other Metrics

Many people confuse Net Operating Income with other financial terms. Here is a simple explanation.

NOI vs. Net Income

Net income subtracts mortgage payments, taxes, and depreciation.
NOI does not subtract these.

NOI vs. Gross Income

Gross income is total income before expenses.
NOI subtracts expenses.

NOI vs. EBITDA

NOI is used in real estate.
EBITDA is used in business accounting.

Real-Life Example of NOI in Property Valuation

Imagine you want to buy two apartment buildings.

Property A

NOI: $90,000
Price: $1,200,000

Property B

NOI: $110,000
Price: $1,400,000

Which is better?

To find out, calculate the cap rate.

Property A cap rate = 90,000 / 1,200,000 = 7.5%
Property B cap rate = 110,000 / 1,400,000 = 7.85%

Property B offers a higher return and is therefore a better investment, even though it is more expensive.

This shows how important NOI is in decision-making.

Why Net Operating Income Is Reliable

Investors trust NOI because:

It removes personal financial factors
It focuses only on property performance
It makes comparison easy
It is objective, not emotional
It works in all markets

A property may look beautiful, modern, and luxurious, but if the NOI is low, it is not a good investment.

NOI in Commercial vs. Residential Real Estate

Commercial Real Estate

NOI is the main tool for pricing
Investors rely heavily on NOI
Small NOI changes affect property value greatly

Residential Real Estate

NOI is used mainly for rental homes or multifamily properties
Home values usually depend more on the housing market
Still very important for investors

NOI and Risk Assessment

A strong NOI means low risk.
A weak NOI means high risk.

Banks also use NOI to decide how much money they are willing to lend for a property.
If the NOI is too low, the bank may not approve the loan.

Conclusion: Mastering Net Operating Income (NOI)

Net Operating Income is one of the most important numbers in real estate investing. It shows how much money a property earns after paying its operating expenses. It helps determine property value, measure performance, and guide investment decisions.

If you know what Net Operating Income is, understand how to calculate Net Operating Income, and use it correctly, you will think like a professional investor. You will make smarter choices, avoid bad deals, and find opportunities others miss.