What Is NOI in Real Estate?

Disclaimer: PropStream does not offer financial advice. This article is for informational purposes only. We recommend performing individual research or consulting financial professionals before investing in real estate.

Net operating income (NOI) is how much income a property generates after accounting for operating expenses.

As an investor, if you don’t know this figure before entering a real estate deal, you’re flying blind. Read on to learn how NOI is calculated, how to improve it, and more.

What Is NOI in Real Estate?

NOI stands for net operating income. This is a property’s income left over after operating expenses are paid for. To calculate it, you simply subtract the property’s total operating expenses from its total income. Here’s the formula:

Net Operating Income (NOI) = Total Income - Total Operating Expenses

For example, if a property generates $2,000 per month but has $500 in monthly operating expenses, the NOI would be $1,500 ($2,000 - $500).

Of course, what you count as income and operating expenses can have a big impact on the outcome of your calculations.

What Counts as Property Income?

In real estate, property income mainly comprises rent from tenants.

However, it can also include ancillary income, such as fees collected from on-site parking, storage, or laundry facilities. The same goes for pet fees and late fees. Any income generated directly by the property is considered property income.

What Counts as Operating Expenses?

Operating expenses are the ongoing costs to run and maintain the property. They include:

• Maintenance and repairs: Think regular upkeep, landscaping, and any plumbing, electrical, or HVAC servicing.
• Property taxes: These are taxes assessed by the local government based on the property’s value.
• Insurance: This is typically a monthly premium that helps financially protect the property against damage, liability, or loss.
• Utilities: These are costs for services like water, electricity, gas, or trash that the owner covers (not the tenant).
• Property management: If you outsource property management, this cost is considered an operating expense.
  
• Marketing and leasing: This is what it costs to advertise vacant units to potential tenants and onboard them.
• Administrative costs: These can include anything from office supplies to legal fees to software used to manage the property.

What’s Not Included in NOI

That said, some costs that owners pay are not considered operating expenses:

• Mortgage payments: Loan payments aren’t included in NOI because they’re not related to the property’s operations.
  
• Capital expenditures (CapEx): These are high, one-time costs for major repairs like roof replacements. They’re not included in operating expenses since they’re irregular.
• Income taxes: Income taxes aren’t included in operating expenses since they’re tied to the owner’s broader financial situation, not the property’s operations.

Related Read: How to File Taxes as a Rental Landlord

Step-by-Step NOI Calculation Example

Now that you know what NOI consists of, let’s walk through an example scenario.

Imagine you own a fourplex with the following monthly income:

Tenant rent: $4,000
Laundry facility income: $200
Pet fees: $150
__________________________________
Total monthly income: $4,350

Now imagine you also have the following monthly operating expenses:

Regular maintenance: $400
Insurance: $100
Property taxes: $150
Utilities: $700
Software subscriptions: $50
__________________________________
Total monthly operating expenses: $1,400

To calculate the property’s NOI, subtract your monthly operating expenses from your total monthly income:

$4,350 total monthly income - $1,400 total monthly operating expenses
__________________________________
$2,950
(In this case, your fourplex has a monthly NOI of $2,950.)

Why NOI Matters for Investors

NOI is an important number for investors for a few reasons:

Cap Rate

You need to understand a property’s NOI before you can calculate its capitalization rate (or cap rate). This is the property’s annual return before financing. The formula is:

Cap Rate = Annual NOI / Property Value

For example, if a $500,000 property has an annual NOI of $30,000, its cap rate would be 6% ( $30,000/$500,000).

Property Valuation

Many investors rearrange the cap rate formula to estimate a property’s value based on an average market cap rate. The rearranged formula is:

Property Value = Annual NOI / Cap Rate

For example, if a property generates $40,000 in annual NOI and comparable properties trade at an average 5% cap rate, its estimated value would be $800,000 ($40,000 ÷ 0.05).

Cash Flow Analysis

Once you’ve calculated a property’s NOI, you’re one step away from calculating its cash flow. This is the net amount of money flowing in or out of your property after accounting for financing.

Here’s the formula:

Net Cash Flow = NOI - Debt Service

For example, if a property has a monthly NOI of $1,000 and a monthly mortgage payment of $800, the property’s net cash flow would be $200 ($1,000 - $800).

Lending Decisions

Many lenders require a property to meet a minimum debt service coverage ratio (DSCR) to qualify for financing (often 1.2). To determine DSCR, you must know the property’s NOI first.
Here’s the formula for DSCR:

Debt Service Coverage Ratio (DSCR) = NOI / Debt Service

For example, if a property has a monthly NOI of $1,500 and a monthly mortgage payment of $1,000, its DSCR would be 1.5 ($1,500 / $1,000).

Any DSCR above 1.0 means the property can cover its debt service; anything below 1.0 means it can’t, and 1.0 means it’s breaking even.

So if you need a rental loan, focus on increasing the property’s NOI, which boosts its DSCR.

Common NOI Mistakes Investors Make

Whatever you do, don’t make these common NOI calculation mistakes:

Tips for Improving an Investment Property’s NOI

To increase NOI, there are two main levers you can pull: increasing income or lowering operating expenses. Here are some ideas on how to do both:

Increase Income

• Raise rents to market rates: Do it strategically, such as during lease renewals, without pricing out good tenants.
• Reduce vacancies: Improve your marketing and tenant screening to minimize turnaround and time between leases.
• Add income streams: Consider charging for storage units, laundry facilities, or other ancillary services.

Lower Operating Expenses

• Negotiate vendor contracts: Bundle services or negotiate long-term contracts with contractors for better rates.
• Perform preventative maintenance: Address small issues before they become expensive repairs.
• Self-manage where possible: Cutting out property management fees can significantly lower your expenses, though it requires more work on your part.

Simplify Rental Property Analysis With PropStream

As an investor, you need to vet deals quickly. The faster you can evaluate a potential investment, the faster you can seize it or move on to the next opportunity. So why waste time calculating NOI manually?

If you want to streamline your due diligence, check out PropStream’s new Rental ROI Calculator. By entering a few deal assumptions, it’ll tell you the property’s projected NOI, cash flow, cap rate, ROI, and more.