Net operating income is a property's total revenue minus vacancy and credit loss minus all operating expenses, calculated before any debt service payments, income taxes, depreciation, and capital expenditures. That 'before debt' boundary is not incidental; it is the metric's defining feature.
Because NOI sits above the financing line, it is a property-level measure of economic productivity that is the same whether the building is owned free and clear or encumbered with a mortgage. This makes NOI the universal CRE performance metric: lenders, appraisers, asset managers, and equity underwriters all begin with NOI before applying their own discipline's lens.
The income side of the NOI calculation starts with gross potential revenue (rent at 100% occupancy plus other income such as parking, antenna fees, and laundry revenue) and then deducts a vacancy and credit loss allowance to arrive at effective gross income. From EGI, the operating expense deductions follow: property taxes, insurance, property management fees, routine maintenance and repairs, utilities paid by the landlord, and janitorial and landscaping.
What does not appear above the NOI line is equally important: mortgage principal and interest, tenant improvement allowances, leasing commissions, and capital expenditures such as roof replacements and major mechanical upgrades are all excluded. Whether to include a reserves-for-replacement line is debated among practitioners; institutional appraisers frequently deduct a replacement reserve, while lenders often underwrite without one and instead stress the DSCR using a capital expenditure overlay.
NOI drives three distinct workflows across the industry. In valuation, the income capitalization approach produces value as NOI divided by the market cap rate; a $1.2 million NOI capitalized at 5.5% implies a $21.8 million property value.
In lending, debt service coverage ratio equals NOI divided by annual debt service; most institutional lenders require a minimum 1.20x-1.25x DSCR at underwriting. In asset management, NOI per square foot, NOI margin (NOI as a percentage of EGI), and NOI growth relative to budget are the primary performance attribution metrics tracked quarterly against the business plan and against NCREIF benchmarks for the asset class.
Pro-forma NOI routinely overstates likely actual NOI, and identifying the gap is one of the most consequential skills in acquisition underwriting. Common manipulation points include applying a market management fee to an owner-managed property (which can swing NOI by 2-4% of EGI), assuming aggressive stabilized vacancy when in-place vacancy is elevated, normalizing away non-recurring expenses that recur in practice, and excluding reserves for replacement to inflate apparent NOI.
Below-market contract rents on long-term leases will also make stabilized market-rate NOI look higher than the in-place NOI the buyer inherits on day one. A disciplined underwriter runs both an in-place NOI (reflecting actual leases) and a stabilized NOI (reflecting market assumptions) and demands that the seller's stated NOI be reconciled to actual trailing operating statements before the price is agreed.
The income side begins with gross potential revenue (rent at full occupancy plus other income such as parking, storage, and antenna or laundry revenue), then deducts a vacancy and credit-loss allowance to reach effective gross income (EGI). From EGI you subtract operating expenses: property taxes, insurance, property management fees, routine repairs and maintenance, landlord-paid utilities, and janitorial and landscaping. The result is NOI.
What sits below the NOI line is just as important as what sits above it. Mortgage principal and interest (debt service), income tax, depreciation, tenant-improvement allowances, leasing commissions, and capital expenditures such as roof and major mechanical replacements are all excluded. Excluding debt service is the point: it keeps NOI a measure of the property's own economic productivity, independent of how any given owner financed it.
The income capitalization approach values a property as NOI divided by a market capitalization rate, so a $1.2 million NOI at a 5.5% cap rate implies roughly a $21.8 million value. Because value scales directly with NOI, the integrity of the NOI figure determines the integrity of the valuation, which is why appraisers scrutinize each expense line and the reserve treatment before capitalizing.
The same figure drives lending and asset management. Debt service coverage ratio is NOI divided by annual debt service, and most institutional lenders require at least 1.20x to 1.25x at underwriting; debt yield is NOI divided by the loan amount. Asset managers track NOI margin (NOI as a share of EGI), NOI per square foot, and NOI growth versus budget and against NCREIF benchmarks for the asset class.
A seller's pro-forma NOI routinely overstates the income a buyer will actually inherit, and spotting the gap is central to acquisition underwriting. Common inflation points include applying a market management fee to an owner-managed property, assuming an aggressive stabilized vacancy when in-place vacancy is higher, normalizing away expenses that in fact recur, and omitting a replacement reserve.
A disciplined underwriter runs both an in-place NOI (from actual leases and trailing operating statements) and a stabilized NOI (on market assumptions), and reconciles the seller's stated figure to the trailing financials before agreeing a price. Below-market contract rents on long leases can also make a stabilized market-rate NOI look higher than the income the buyer receives on day one.
NOI is a property's effective gross income minus its operating expenses, calculated before debt service, capital expenditures, income tax, and depreciation. Because it sits above the financing line, it measures the property's own income-producing ability regardless of how the owner financed the asset.
Start with gross potential rent plus other income, subtract vacancy and credit loss to get effective gross income (EGI), then subtract operating expenses (taxes, insurance, management, repairs, utilities, janitorial). EGI minus operating expenses equals NOI. Debt service, capital expenditures, income tax, and depreciation are not subtracted.
No. Mortgage principal and interest are excluded from NOI by design. Leaving debt service out keeps NOI a property-level measure that is the same whether the building is owned free and clear or mortgaged, which is exactly why lenders and appraisers rely on it.
No. Capital expenditures such as roof replacements, major mechanical upgrades, tenant-improvement allowances, and leasing commissions fall below the NOI line. Practitioners disagree on whether to deduct a recurring replacement reserve: institutional appraisers often do, while many lenders underwrite without one and stress the DSCR instead.
NOI is income before financing and capital costs. Cash flow after debt service subtracts mortgage payments, and cash flow after everything also reflects capital expenditures, leasing costs, and taxes. NOI measures the asset; cash flow measures what a particular owner keeps after its financing and capital spending.
No. Depreciation is an accounting and tax item, not an operating expense, so it is excluded from NOI. Including it would mix a non-cash tax concept into a cash-based measure of property operations and break the comparability that makes NOI useful across differently financed assets.