Net operating income (NOI)

What Is Net Operating Income or NOI?

In real estate, Net Operating Income, or NOI, is a measure of an investment property's income stream. The NOI is used as a basis for estimating an investment property's market value under the capitalization approach. The NOI is also key to assessing a property's potential returns and cash flow.

The Net Operating Income is measured by deducting operating expenses from the gross income generated by the property. The NOI can draw from a property's actual performance, but a pro forma analysis is meant more to gauge an investment property's performance against other comparable properties in the same investment real estate market.

The Pro Forma Net Operating Income (NOI) Formula

In the investment real estate industry, there is a conventional formula used to determine NOI. This formula incorporates market assumptions such as expected market rents and vacancy rates into the calculation of Net Operating Income for pro forma statements.

The Scheduled Gross Income represents the total potential revenue a property could produce. Vacancy is a deduction from Scheduled Gross Income to account for the fact that the property will not always be, if ever, fully rented.

Effective Gross Income is the effective operating revenue for a property. It is calculated by subtracting the Vacancy Allowance from the Scheduled Gross Income.

The Operating Expenses are the financial charges incurred due to the operations of a property. These charges include property management, utilities, maintenance, insurance, and property taxes. Depreciation and interest expenses are not included.

Net Operating Income is the resulting number that represents the income stream of the property. From NOI, we can apply a capitalization rate (cap rate) to estimate the market value of the investment property. We can also calculate the property's cash flow and cash on cash return with NOI as a starting point.