Net Operating Income Definition and Calculation

Net operating income (NOI) is calculated by subtracing the operating expenses from the gross revenues of an income producing property. NOI is calculated before accounting for the debt service obligations of the property. Real Estate investors use the net operating income to value almost every commercial and residential income producing property. Along with a capitalization rate, or cap rate, you can place a value on any given property. In order to do so, take the NOI of a potential real estate investment and then divide the NOI by the market cap rate. Cap rates will vary from market to market and also differ based on what type of asset you are valuing. Until recently, cap rates were at historic lows, which tends to favor sellers, but cap rates are slowly on the rise as the real estate and credit markets have turned.

Here's an example, let's assume you have a ten unit apartment building with average rents of $500 dollars per month, and annually you collect another $5,000 dollars in other fees, such as cleaning deposits and pet fees. Annually your gross revenues will be about $65,000. Let's also assume you that your total expenses run about $20,000 dollars annually. This includes your property taxes, management fees, insurance, lawn care, and any other general expense items. This does not include capital expenditures or debt service. Your NOI based on the preceding numbers would be $45,000. Now, let's assume you live in a market where cap rates on apartment buildings average about 8.0%. Now, we are ready to place a value on your apartment building. Take the $45,000 Net Operating Income and divide it into 8.0%. This gives us a value of about $562,500 for your 10 unit apartment building, or about $56,000 per unit.

Net Operating Income Calculation

Gross Income
- Operating Expenses (does not include debt service)
= Net Operating Income