How to Calculate NOI on a Rental Property (Examples)

Net operating income (NOI) is the yearly profit a rental property produces before the mortgage and income taxes. It is the number lenders use to size a loan, the number buyers use to value a building, and the number that tells you whether a property can carry its debt. This guide builds NOI line by line for a duplex, then uses it for cap rate, debt coverage and cash flow. To test your own deal, plug the result into the cap rate calculator.

The NOI formula

NOI = effective gross income − operating expenses. Effective gross income (EGI) = gross potential rent − vacancy and credit loss + other income. Gross potential rent is what you would collect if every unit were rented all year at market rent. Vacancy and credit loss covers empty months and unpaid rent. Other income is laundry, parking, storage, pet rent and late fees. Operating expenses are the costs of running the property.

What counts as an operating expense

Include: property taxes, landlord insurance, repairs and routine maintenance, property management (even if you manage it yourself, because your time has a cost and a buyer or lender will price it in), utilities the owner pays (often water, sewer and trash), HOA dues, landscaping and snow removal, pest control, advertising and tenant screening, accounting and legal fees, and a maintenance reserve. Leave out: mortgage principal and interest, depreciation, your income taxes, and capital improvements such as a new roof or HVAC system. Many investors also set aside a capital-expenditure reserve and show it below NOI, so a 'NOI after reserves' figure is a useful second line.

Worked example: a duplex

Two units rent for $1,450 a month each. Gross potential rent: 2 × $1,450 × 12 = $34,800. Vacancy and credit loss at 5%: $1,740. Coin laundry brings in $40 a month: $480 a year. Effective gross income: $34,800 − $1,740 + $480 = $33,540. Operating expenses: property taxes $3,900; insurance $1,800; repairs and maintenance $2,100; management at 8% of EGI $2,683.20; water, sewer and trash $1,500; lawn and snow $600. Total: $12,583.20. NOI: $33,540 − $12,583.20 = $20,956.80 a year, or about $1,746 a month. The expense ratio (operating expenses ÷ EGI) is 37.5%.

From NOI to cap rate and value

Cap rate = NOI ÷ price. At a $310,000 asking price the duplex's cap rate is $20,956.80 ÷ $310,000 = 6.76%. Turned around, value = NOI ÷ cap rate, which is why NOI drives price: raising rent by $50 per unit adds $1,200 of NOI a year, and at a 6.76% cap rate that is worth about $17,750 of value. Cutting a $1,200 expense does the same. Compare the cap rate with similar properties in the same area; a cap rate well above the local norm usually means a higher-risk building, area or rent roll, not a bargain.

Debt service coverage (DSCR)

Lenders divide NOI by the annual mortgage payment. Suppose you borrow 75% of $310,000 ($232,500) at 6.75% for 30 years. The monthly principal and interest is about $1,507.99, or $18,095.89 a year. DSCR = $20,956.80 ÷ $18,095.89 = 1.16. Many lenders want at least 1.20 to 1.25 for an investment property, so this deal would likely need a bigger down payment, a lower price, or higher rents to qualify. A DSCR below 1.0 means the property's income does not cover its mortgage.

From NOI to cash flow

Cash flow before tax = NOI − annual debt service. Here: $20,956.80 − $18,095.89 = $2,860.91 a year, about $238 a month. On the $77,500 down payment that is a 3.7% cash-on-cash return before closing costs, and before any capital-expenditure reserve. That thin margin is normal at current rates; it is why the rental cash flow calculator is worth running on every listing before you make an offer.

A single-family example

A house rents for $2,100 a month: gross potential rent $25,200. Vacancy at 6% (one empty month every 16 to 17 months, roughly): $1,512, so EGI is $23,688. Expenses: taxes $4,200, insurance $1,650, repairs $1,500, tenant-placement and management $1,300, total $8,650 (the tenant pays all utilities). NOI: $23,688 − $8,650 = $15,038. At a $285,000 price that is a 5.28% cap rate.

Mistakes that inflate NOI

Using asking rent instead of what similar units actually rent for. Leaving out vacancy because the unit is rented today. Leaving out management because you plan to self-manage. Using last year's tax bill when a sale will trigger a reassessment. Counting the mortgage as an expense (it understates NOI) or ignoring capital expenditures entirely (it overstates what you keep). A seller's 'pro forma' NOI is a forecast; ask for the trailing twelve months of actual income and expenses and rebuild it yourself.

Quick sanity checks

Operating expenses for small residential rentals commonly run somewhere around 35% to 50% of gross rent once management, repairs and reserves are included; the '50% rule' is a rough screen built on that, not a substitute for real numbers. If a seller's figures show expenses at 20% of rent, find out what is missing. For a deeper look at how rental income is taxed and depreciated, see rental income explained and the rental property depreciation calculator.

Your NOI worksheet

1) Gross potential rent at market rates. 2) Minus vacancy and credit loss (5% to 8% is a common starting assumption; use local data if you have it). 3) Plus other income. 4) Minus every operating expense, including management and a maintenance allowance. 5) The result is NOI. Then divide by price for the cap rate, divide by the annual mortgage for DSCR, and subtract the mortgage for cash flow.