Net operating income (NOI): what it means for a rental property

Net operating income, or NOI, is what a rental earns in a year after its operating costs and before any loan payment. It measures the property, not your financing, so two buyers with different loans on the same property get the same NOI.

That's why NOI shows up in cap rate, in pro formas, and in most ways of valuing income property. Get it wrong and every number built on it is wrong too.

The NOI formula

NOI = gross rental income − vacancy − operating expenses

Start with the full scheduled rent for the year. Subtract an allowance for months the property sits empty. Then subtract the costs of running it.

Wall Street Prep describes NOI as income minus direct operating expenses, figured before debt service, interest, depreciation, capital expenditures, and income taxes.

What counts as an operating expense, and what doesn't

Loan payments sit outside NOI because they depend on how you financed the property, not on how the property performs.

Depreciation is a tax deduction, not a cash cost. IRS Publication 527 says residential rental buildings are generally depreciated over 27.5 years and land isn't depreciated. It matters on your tax return. It doesn't belong in NOI.

Capital improvements are also outside. Pub 527 draws the line for tax purposes: ordinary repairs are deductible as expenses, while improvements are capitalized and recovered through depreciation. A patched leak is a repair. A replaced roof is an improvement. You still need cash set aside for capital items, but that money comes out below NOI.

A worked example: 2107 S Seale Rd

The Lineage listing at 2107 S Seale Rd in Phenix City, Alabama, is priced at $230,000 with estimated rent of $1,800 a month, taxes of $226 a month, and insurance of $74 a month. The listing doesn't state management, repairs, or vacancy, so the figures for those three below are example inputs to show the math. They aren't Lineage's numbers or market averages.

Note what isn't in the table: the $997 interest-only loan payment at 6.5% (the site says it's not a Lineage quote). That comes after NOI. On this example, $1,176 a month minus $997 leaves $179 a month in cash flow. That's lower than the $295 a month the plan builder models, because the example costs here for management, repairs, and vacancy total $324 a month, more than the plan's figure allows for. Your own inputs decide which is closer.

To run this on a real listing with your own inputs, build my plan. No sign-up.

How NOI feeds cap rate and DSCR

Cap rate is NOI divided by price.

$14,112 ÷ $230,000 = about 6.1%

Because NOI ignores financing, cap rate lets you compare properties regardless of how each is financed. It doesn't tell you your return on your own cash. That's cash-on-cash. See real estate investment metrics for how the measures fit together.

DSCR, the debt service coverage ratio, compares income to the loan payment. In commercial lending, it's often NOI divided by annual debt service. On this example, that would be $14,112 ÷ $11,964, or about 1.18.

On a single rental, a lender's DSCR is usually figured a simpler way: monthly rent divided by the full monthly payment, meaning the loan payment plus taxes, insurance, and any HOA dues. That's how the Lineage site shows it. On Seale Rd, $1,800 ÷ $1,297 = 1.39. The two numbers measure different things, so don't compare one property's NOI-based ratio to another's rent-based one. Our post on how to calculate DSCR walks through the lender's version, and the DSCR loan calculator runs it for you.

Common NOI mistakes

Subtracting the mortgage. NOI is before debt service. Rent minus everything including the loan is cash flow, a different number.

Leaving out vacancy. A pro forma that assumes 12 full months of rent every year overstates NOI. Even a well-run property turns over.

Counting a capital item as a yearly expense, or forgetting it exists. A roof replacement doesn't belong in one year's NOI. You still need cash for it, so plan reserves separately.

Subtracting depreciation. It lowers taxable income. It doesn't lower NOI.

Comparing NOIs built on different assumptions. If one listing's NOI includes management and another's doesn't, the comparison is meaningless. Read every line. Our guide on how to read a pro forma shows where to look.

Illustrative example. Management, repairs, and vacancy figures are examples, not Lineage figures. Actual results vary based on market conditions, property performance, and financing terms. This is education, not tax or investment advice. Your CPA confirms how deductions apply to you.

NOI ends where the loan payment starts, and on this example that line is the difference between $1,176 and $179 a month. Build my plan to see it on a real listing, or talk to a consultant.