Net Operating Income

by Obaidullah Jan, ACA, CFA

In real estate investment analysis, net operating income (NOI) is an unlevered measure of a property’s income potential. It equals the property revenues minus all operating expenses. NOI is used in direct capitalization method and discounted cash flow method to arrive at a property’s intrinsic value.

As evident from its name, net operating income includes only ‘operating’ income and expenses. It is similar to EBITDA in that it is before deduction of any depreciation expense, interest expense and income tax. NOI is similar in concept to the incremental cash flow in capital budgeting.

Typical examples of revenues included in calculation of NOI are effective gross rent, parking fees, storage fees, etc. Effective gross rent equals gross rent minus vacancy and collection losses. Standard expense items which are subtracted from total net revenue to arrive at the NOI include property taxes, insurance, utilities, repairs and maintenance, etc. An appropriate charge representing the expense incurred on replacement of modifications carried out by the tenant is also subtracted.

In the direct capitalization method, the net operating income is divided by the cap rate i.e. the capitalization rate to arrive at a property’s value.

$$ V=\frac{NOI}{r\ -\ g} $$

Where V is the property value, r is the cap rate and g is the constant growth rate of NOI.

In the discounted cash flow method, net operating income is forecasted for foreseeable future and a resale value (i.e. reversion value or terminal value) of the property at the end of the foreseeable period is determined. The forecasted NOI and reversion value is discounted back to time 0 using a discount rate which is representative of the property’s risk.

$$ V=\frac{{\rm NOI}_1}{{(1+r)}^1}+\frac{{\rm NOI}_2}{{(1+r)}^2}+...+\frac{{\rm NOI}_n}{{(1+r)}^n}+\frac{RV}{{(1+r)}^n} $$

Where NOI1, NOI2 and NOIn are the net operating income in first, second and nth period, RV is the reversion value (terminal value) and r is the appropriate discount rate.


You are managing a 100-unit apartment complex that would generate $1 million per annum in rent at full capacity. Calculate the property’s NOI give the following information:

  • On average 20% of the apartments stay vacant.
  • 10% of the tenants fail to pay at all on average.
  • $20,000 per month is earned from non-invasive advertising.
  • Property taxes are 5% and income tax is 30%.
  • The property was constructed using 20% equity and 80% $200 million 8%-APR 30-year loan.
  • Operating expenses are 40% of the full capacity rent.

The following table calculates net operating income of the property and highlights why a revenue or expense item is included or excluded.

Item Amount in USD Rationale
Gross rent 5,000,000 This represents income when the property is 100% occupied.
Other income 240,000 This represents $20,000 earned per month from advertising.
Potential gross revenue 5,240,000
Vacancy losses (1,000,000) It equals 20% of the gross rent.
Total revenue 4,240,000
Collection loss (424,000) It equals 10% of the total revenue.
Net revenue 3,816,000
Operating expense (2,000,000) It equals 40% of the gross rent.
Property taxes (250,000) It equals 5% of the gross rent.
Interest expense Interest expense is ignored in calculating NOI.
Income tax NOI is a before income tax measure hence income tax is not subtracted.
Net operating income (NOI) 1,566,000