Before you look at a cap rate, a loan quote or a projected return, you need one number you trust: net operating income, or NOI. It is the income an apartment building produces after paying its own running costs, and nearly every other figure in the deal is built on top of it. If the NOI is wrong, the price you offer, the loan you can get and the cash flow you expect will all be wrong in the same direction. This guide explains what goes into NOI, what stays out, and walks through a full example with made-up numbers.
Key takeaways
- NOI = effective gross income minus operating expenses.
- Loan payments, income taxes, depreciation and capital projects are not operating expenses.
- Build NOI as the next owner would run the building, not as the seller reports it.
- Small errors in NOI become large errors in value, because value is NOI divided by a cap rate.
What goes into net operating income
NOI has two halves. The first is effective gross income: the rent the building would collect if every unit were leased at its current rent, minus vacancy, concessions and bad debt, plus other income such as parking, storage or laundry. The second is operating expenses: every recurring cost of keeping the building open and rented. Subtract the second from the first and you have NOI.
The definition sounds simple, but most arguments between buyers and sellers happen inside those two halves. A seller may show scheduled rent with no vacancy, count a one-time insurance refund as income, or leave out a management fee because they manage the building themselves. None of that is dishonest on its own, but none of it describes what you will earn.
What stays out of NOI
- Debt service. Mortgage principal and interest depend on the buyer’s loan, not on the building, so they come after NOI.
- Capital expenditures. A new roof, windows or a boiler replacement are investments, not running costs. They belong in a reserve or a capital budget.
- Income taxes and depreciation. These depend on the owner’s tax situation.
- The owner’s personal costs. Travel, a home office or a car do not belong to the property.
Keeping these items out is what makes NOI comparable from one building to another. Two identical buildings with different owners and different loans should have roughly the same NOI.
A worked example
Take a hypothetical 12-unit building. Every figure below is made up to show the method, not to describe the Seattle market.
| Line | Annual amount | How it was built |
|---|---|---|
| Gross scheduled rent | $259,200 | 12 units x $1,800 x 12 months |
| Less vacancy and credit loss | -$12,960 | 5% of scheduled rent |
| Plus other income | +$7,200 | Parking and laundry actually collected |
| Effective gross income | $253,440 | |
| Property taxes | -$28,000 | Estimated at the new owner’s value |
| Insurance | -$9,500 | Fresh quote, not the seller’s policy |
| Utilities paid by owner | -$16,800 | Water, sewer, garbage, common electric |
| Repairs, maintenance and turnover | -$18,000 | Building’s age and unit count |
| Management | -$15,200 | About 6% of effective income |
| Registration, admin, other | -$4,500 | City fees, accounting, supplies |
| Total operating expenses | -$92,000 | |
| Net operating income | $161,440 | Effective income minus expenses |
Notice what happened to the management line. If the seller self-managed, their statement may show zero. A buyer who hires a manager, or who wants to be paid for their own time, has to add it back. The same logic applies to property taxes: the seller’s bill reflects the old assessed value, and a sale can change what the assessor thinks the building is worth.
Why a small error matters so much
Value is commonly estimated as NOI divided by a market cap rate. At a 5.5% cap rate, the example NOI of $161,440 implies a value of about $2.94 million. Now suppose the seller’s version left out management and used last year’s taxes, and showed an NOI of $182,000. At the same cap rate that implies about $3.31 million. The difference, roughly $370,000, came from about $20,000 a year of missing expenses. This is why rebuilding NOI yourself is the most valuable hour you can spend on a deal. Our guide to Cap Rate vs. Cash-on-Cash Return: Which One Tells You More? explains how the cap rate side of that equation works.
How to build your own NOI, step by step
- Start with the rent roll, not the listing. Add up current rents unit by unit.
- Compare that total with the collected rent in the seller’s trailing twelve months, and find out why they differ.
- Choose a vacancy and credit-loss allowance that fits the building’s history and the neighborhood.
- Count only other income that is actually collected and will continue under new ownership.
- Rebuild each expense line: new tax estimate, fresh insurance quote, owner-paid utilities, repairs, turnover, management and city fees.
- Subtract, and write down every assumption next to the number it produced.
Tip: Keep two columns side by side: the seller’s figures and yours. The lines where they differ most are the questions to ask before you make an offer.
Where to go from here
Once you have an NOI you believe, the next steps are pricing and financing. The rent side of the calculation is covered in depth in How to Read a Rent Roll Before You Make an Offer, and the expense side in Apartment Operating Expenses: Building a Budget as the Next Owner. When you add a loan, DSCR: How Lenders Size an Apartment Loan shows how lenders use NOI to decide how much they will lend.