How Is Net Operating Income (NOI) Calculated?

Net Operating Income (NOI) is a key metric in real estate, showing a property’s income-generating potential. This financial measure is widely used by investors to assess a property’s profitability, by lenders to evaluate loan risk, and by appraisers to determine property value. Understanding NOI allows stakeholders to gauge a property’s earnings from operations before considering financing or tax obligations. It serves as a standardized benchmark, enabling comparisons across various real estate investments.

Understanding Gross Operating Income

To calculate Net Operating Income, first determine Gross Operating Income (GOI), which represents the total potential revenue a property can generate. This begins with Potential Gross Income (PGI), the maximum rental income achievable if all units or spaces within a property were occupied and rented at their full market value. For instance, a building with ten units each renting for $1,000 per month would have a PGI of $120,000 annually.

Beyond base rent, properties often generate additional revenue streams, collectively known as other income. This can include fees from laundry facilities, parking spaces, vending machines, or tenant reimbursements for certain utilities. These supplementary earnings contribute to the property’s overall revenue picture.

However, it is necessary to account for potential revenue losses, categorized as vacancy and collection loss. Vacancy loss refers to the income lost when units are unoccupied or unrented, while collection loss accounts for rent that is due but remains uncollected from tenants. To arrive at the Gross Operating Income, these anticipated losses are subtracted from the sum of the Potential Gross Income and any other income. This provides a realistic figure for the property’s total revenue, reflecting its earning capacity and the impact of non-occupancy or uncollected payments.

Identifying Operating Expenses

After calculating Gross Operating Income, the next step involves deducting all operating expenses. These are the costs directly associated with the day-to-day running and maintenance of the property. Property taxes, which are annual assessments levied by local government based on the property’s assessed value, constitute a significant operating expense.

Insurance premiums are another necessary operational cost, covering various risks such as property damage, liability, and sometimes loss of rental income. Utilities, including electricity, water, gas, and trash removal, are also considered operating expenses if the property owner is responsible for these charges rather than the tenants. Ongoing maintenance and routine repairs, such as landscaping, cleaning common areas, and minor plumbing fixes, are essential for preserving the property’s condition and appeal.

Property management fees, typically a percentage of the gross rental income, are paid to professionals who oversee the property’s daily operations, including tenant relations and rent collection. Costs associated with advertising and marketing vacant units to attract new tenants are also deductible as operating expenses. Finally, administrative costs, such as office supplies, legal fees, or bookkeeping services, contribute to the overall operational burden. All these expenses are directly tied to the property’s function and are necessary to keep it generating income.

Items Excluded from NOI

Net Operating Income reflects a property’s operational performance, so certain financial outflows are excluded from its calculation. This metric is understood as being “pre-debt,” “pre-tax,” and “pre-capital expenditure,” providing a clear view of the property’s inherent earning power. Therefore, debt service payments, which include both the interest and principal portions of a mortgage loan, are not subtracted when calculating NOI. These are financing costs related to how the property is owned, not how it operates.

Similarly, income taxes (federal, state, or local) are excluded because they are owner-level expenses, not property-level operating costs. These taxes depend on the owner’s overall financial situation and legal structure. Capital expenditures (CapEx) are also not included in the NOI calculation. These are significant, non-recurring expenses for major improvements like a new roof, HVAC system, or substantial renovations that extend the property’s useful life.

Unlike routine maintenance, capital expenditures represent investments in the property’s long-term value, not daily operational upkeep. Finally, depreciation, a non-cash accounting expense, is also excluded from NOI. It does not represent an actual cash outflow for operations and is primarily for tax accounting purposes.

The NOI Formula and Practical Application

The Net Operating Income (NOI) is calculated using a straightforward formula: Gross Operating Income minus Operating Expenses. This calculation provides a standardized measure of a property’s profitability before accounting for financing, income taxes, or major capital improvements.

For example, consider a commercial property with a Potential Gross Income (PGI) of $200,000 annually. This property also generates $5,000 in other income from parking fees and vending machines. However, it experiences an estimated vacancy and collection loss of $10,000 per year. Therefore, the Gross Operating Income (GOI) for this property is $200,000 (PGI) + $5,000 (Other Income) – $10,000 (Vacancy/Collection Loss), totaling $195,000.

Next, we account for the operating expenses. Assume annual property taxes are $25,000, insurance costs $8,000, utilities paid by the owner amount to $12,000, and routine maintenance and repairs are $15,000. Additionally, property management fees are $10,000, advertising costs $3,000, and administrative expenses are $2,000. The sum of these operating expenses is $75,000.

To find the Net Operating Income, we subtract the total operating expenses from the Gross Operating Income: $195,000 (GOI) – $75,000 (Operating Expenses) = $120,000. This $120,000 represents the property’s Net Operating Income. This final figure is widely used to evaluate a property’s investment viability and to compare the performance of different properties within the real estate market.