How do you calculate net operating income (NOI)?
Net operating income is effective gross income minus operating expenses. Effective gross income is gross potential rent less vacancy, concessions and credit loss, plus other income. The arithmetic is trivial; the difficulty is deciding which lines count as operating expenses, because debt service, capital expenditure, tenant improvements, leasing commissions, depreciation and income taxes are all excluded by definition.
The revenue stack
Start at gross potential rent, which is every unit or suite at market rent as if fully occupied and paying. Subtract loss to lease to get to contract rent, then subtract vacancy, concessions and bad debt. Add other income: parking, storage, laundry, pet fees, utility reimbursement, late fees, and in commercial deals the expense recoveries. The result is effective gross income.
Order matters less than consistency. What matters is that every deduction appears exactly once and that the model uses the same stack in year one that it uses in year ten.
| Line | Amount |
|---|---|
| Gross potential rent | 4,871,000 |
| Less vacancy and credit loss | (341,000) |
| Plus other income | 198,000 |
| Effective gross income | 4,728,000 |
| Less operating expenses | (1,708,000) |
| Net operating income | 3,020,000 |
What counts as an operating expense
Real estate taxes, property insurance, utilities not billed back, repairs and maintenance, contract services such as landscaping and trash, on-site payroll, the property management fee, general and administrative, marketing and leasing costs that are not commissions.
The test is whether the cost recurs in the ordinary course of running the property. A quarterly HVAC service contract does. Replacing the HVAC system does not.
What is excluded, and why people get it wrong anyway
Debt service is excluded because net operating income is a property-level measure, independent of how the buyer financed it. That is the whole reason cap rates are comparable across deals. Capital expenditure, tenant improvements and leasing commissions are excluded because they are investments in the asset rather than the cost of operating it. Depreciation and income taxes are excluded because they are attributes of the owner, not the building. Owner distributions and partnership costs never belonged there at all.
The exclusion people fight over is replacement reserves. The US convention treats reserves as below the line, so a reported net operating income usually does not carry them. Lenders and appraisers frequently deduct a reserve anyway, at a per-unit or per-square-foot rate, before they size a loan or apply a cap rate. Both conventions are defensible. What is not defensible is buying on a no-reserve net operating income and then selling into an appraisal that deducts one.
- Excluded: debt service, principal, interest
- Excluded: capital expenditure, tenant improvements, leasing commissions
- Excluded: depreciation, amortization, income taxes
- Excluded: owner distributions, entity level costs
- Convention-dependent: replacement reserves
Why two analysts get two different NOIs on the same building
Because normalization is a set of choices. Management fee at the seller's rate or at market. Taxes at the current assessment or at the reassessed value after sale. Insurance at the legacy premium or at a fresh quote. Payroll at the seller's staffing or yours. General vacancy at physical occupancy or at a stabilized underwriting standard. Every one of those is a judgment, and each one moves the number.
This is why a net operating income figure without its assumptions is not information. It is a headline.
Whose NOI goes in the cap rate
A cap rate is net operating income divided by value, but three different net operating incomes get used: trailing, forward twelve months, and stabilized. The trailing number prices what the asset does today. The forward number prices the next year under your ownership and is what most buyers actually transact on. The stabilized number prices a future that requires capital and time to reach, and quoting a cap rate on it without discounting for that risk is how a deal gets overpaid for.
Altyst builds the whole stack explicitly, with rent and expenses on separate growth curves, a per-year growth schedule where a flat rate will not do, and custom lines that carry their own growth rate, so a tax line capped by statute does not have to drift with everything else. Every figure exposes the formula behind it and the inputs it depends on.
Related questions
What is the formula for NOI?
Net operating income equals effective gross income minus operating expenses. Effective gross income equals gross potential rent, less vacancy, concessions and credit loss, plus other income and recoveries.
Is debt service included in NOI?
No. Net operating income is measured before debt service, which is what makes it comparable across properties regardless of how each buyer financed the purchase.
Are capital expenditures included in NOI?
No. Capital expenditure, tenant improvements and leasing commissions are investments in the asset and sit below net operating income, not inside it.
Should replacement reserves be deducted before NOI?
By US convention reserves sit below the line, so reported net operating income usually excludes them. Lenders and appraisers commonly deduct a per-unit or per-square-foot reserve anyway when sizing debt or applying a cap rate, so it is worth knowing which convention a quoted figure uses.
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