NOI formula: how to calculate NOI
NOI equals effective gross income minus operating expenses, where effective gross income is potential rent and other income less vacancy and collection loss.[1]
| Line | Amount |
|---|---|
| Gross potential income | $118,200 |
| Less vacancy and credit loss (6%) | ($7,092) |
| Effective gross income | $111,108 |
| Less property taxes | ($14,500) |
| Less insurance | ($6,200) |
| Less utilities paid by owner | ($6,240) |
| Less other operating costs | ($3,600) |
| Less repairs and maintenance (6% of rent) | ($6,912) |
| Less capital reserves (4% of rent) | ($4,608) |
| Less property management (7% of collected income) | ($7,778) |
| Net operating income | $61,270 |
| Operating expense ratio | 44.9% |
What counts as an operating expense
An operating expense is a recurring cost of running the property; financing and the owner's taxes are not. Fannie Mae's underwriting rules list interest, principal payments, depreciation, amortization and financing fees as items not to include.[1] The usual lines:
- Property taxes and insurance, from the actual bill and a current quote.
- Repairs and maintenance: routine fixes, turnover painting, service calls.
- Management: a fee on collected rent if you hire a manager, or a fair cost for your own time.
- Owner-paid utilities, HOA dues, landscaping, snow and trash.
- Replacement reserves: money set aside each year for items that wear out, such as roofs, appliances and parking lots. Fannie Mae requires at least $200 per unit per year and subtracts it just below NOI; this worksheet keeps reserves among the operating lines, which is more conservative.[1]
Left out of NOI: mortgage principal and interest, depreciation, the cost of major improvements (as opposed to reserves for them), income tax and one-time acquisition costs. For tax returns the rules differ: mortgage interest and depreciation are deductible rental expenses, and improvements are depreciated rather than deducted at once.[3]
How lenders underwrite NOI
Agency lenders do not take a seller's NOI at face value; they apply minimums. Fannie Mae's multifamily guide sets these floors among others:[1]
| Line | Fannie Mae multifamily minimum |
|---|---|
| Vacancy, concessions and bad debt | The greater of the actual collection gap or 5% of gross potential rent |
| Management fee | The greatest of 3% of effective gross income, the actual fee or the appraiser's market fee |
| Real estate taxes | The greater of the actual future full-year bill or the prior year × 103% |
| Insurance | A new 12-month quote, or 105%–110% of the current cost depending on time left on the policy |
| Replacement reserve (below NOI) | At least $200 per unit per year |
| Not income | Security deposits, insurance proceeds, interest income, gain on sale |
Applying the same floors to your own numbers is a good way to see the NOI a lender is likely to use.
Operating expense ratio formula
The operating expense ratio is operating expenses divided by effective gross income; in the example it is 44.9%. It is a quick check on whether an expense budget is complete. A seller's statement that shows a much lower ratio than similar buildings usually leaves something out, often management, reserves or a tax reassessment after the sale.
Using NOI
- Value: NOI ÷ cap rate.[2] At a 6.5% cap rate, $61,270 of NOI implies about $942,622. Try it in the rental property value calculator.
- Cap rate: NOI ÷ price, on the cap rate calculator.
- Loan size: lenders divide NOI by the debt service to get the DSCR.
- Cash flow: NOI minus the mortgage, on the rental cash flow calculator.
Actual vs pro formaA trailing-12-month NOI uses what the property actually collected and spent. A pro forma NOI uses projected rents and budgets. When buying, compare both and ask why they differ.
Frequently asked questions
What is NOI in real estate?
Net operating income is a property's annual income after vacancy and operating expenses, before debt service, depreciation and income tax. It measures what the building itself earns.
Does NOI include the mortgage payment?
No. Debt service is subtracted after NOI. That keeps NOI comparable between buyers who use different loans.
Is property tax included in NOI?
Yes. Property taxes are an operating expense and are subtracted before NOI. Income tax is not.
Is NOI the same as cash flow?
Only for a property with no loan. With a mortgage, cash flow is NOI minus the year's payments.