Net Operating Income is the single most important number in commercial and investment real estate. Every valuation, every lender calculation, and every cap rate starts with NOI. Understand it cold.
How to Calculate NOI
NOI = Gross Rental Income − Vacancy − Operating Expenses
(Note: NOI does NOT include mortgage payments)
Step-by-Step Example
Gross annual rent: $24,000 ($2,000/month)
Vacancy (7%): −$1,680
Effective gross income: $22,320
Operating expenses:
− Property taxes: $3,600
− Insurance: $1,400
− Property management (9%): $2,009
− Maintenance reserve (10%): $2,232
− Utilities: $0 (tenant-paid)
NOI = $22,320 − $9,241 = $13,079
What's Included in Operating Expenses (and What's Not)
Included in NOI calculation: property taxes, insurance, property management, maintenance, landscaping, utilities paid by owner, HOA fees, pest control, advertising for tenants.
NOT included (below the NOI line): mortgage principal and interest, depreciation, capital expenditures (roof, HVAC replacements), income taxes.
Why NOI excludes mortgage payments: Lenders and appraisers use NOI because it measures the property's inherent income-producing ability independent of how it's financed. This allows fair comparison between properties with different financing structures.
How Lenders Use NOI — The DSCR Calculation
DSCR (Debt Service Coverage Ratio) = NOI ÷ Annual Debt Service (mortgage payments)
Most investment property lenders require DSCR of 1.2-1.25. At $13,079 NOI with a $10,000 annual mortgage payment: DSCR = 1.31 — approved by most lenders.
NOI and Cap Rate
Cap Rate = NOI ÷ Property Value. This means NOI directly determines how much your property is worth to institutional buyers and appraisers. Increase NOI by $2,000/year in a 6% cap rate market and you've added $33,000 in property value ($2,000 ÷ 0.06). This is the math behind forced appreciation through rent increases and expense reduction.
