What it means
NOI starts with all the revenue an asset generates, then subtracts the costs of running it: management, maintenance, insurance, rates, utilities and letting fees. Deliberately excluded are mortgage interest, capital repayments, income tax, depreciation and one-off capital works.
The reason for those exclusions is comparability. Two identical office buildings will produce the same NOI whether one is owned outright and the other is 70% mortgaged, so a buyer can compare the underlying earning power before deciding how to finance it.
NOI matters commercially because property is valued from it. Divide NOI by the market capitalisation rate and you get an estimated value, which means every dollar of recurring cost you remove from a building can add many dollars to its price.
In practice, analysts build NOI from a gross potential income figure, subtract a vacancy and credit loss allowance to get effective gross income, then subtract operating expenses. Lenders use the result to test debt service coverage, and asset managers track it monthly against budget.
Two nuances catch people out. First, NOI is not cash flow: after NOI you still pay interest, principal and capital expenditure, so a positive NOI does not guarantee money in the bank.
Second, the treatment of items such as management fees, reserves for replacement and non-recurring repairs varies between owners, so NOI figures from different sources are not always directly comparable.
In practice
Real-world examples.
Example
A landlord renegotiates the insurance and cleaning contracts on a warehouse estate, saving $48,000 a year. NOI rises by the same amount, and at a 7% capitalisation rate the estate is worth roughly $685,000 more on paper.
Example
A lender assessing a $6,000,000 loan on an apartment block requires NOI to cover annual debt service by at least 1.25 times. With NOI of $560,000 and debt service of $430,000, the coverage is 1.30, so the loan proceeds.
Example
A hotel group reports NOI by property to compare a city centre site with an airport site. The airport hotel has lower revenue but far lower staffing and rates costs, so its NOI margin is higher and it receives the next refurbishment budget.
Think of it
“NOI is income from the property after operating costs-before financing.
Formula
Calculation
Net Operating Income = Effective Gross Income - Operating Expenses, where Effective Gross Income = Gross Potential Income - Vacancy and Credit Losses.
A small retail parade has a gross potential rent of $1,200,000 a year if every unit is let at market rent. One unit is empty for part of the year and one tenant pays late, giving a vacancy and credit loss allowance of $60,000.
Effective gross income = $1,200,000 - $60,000 = $1,140,000.
Operating expenses for the year are $430,000, covering property management, insurance, rates, common area maintenance and repairs.
NOI = $1,140,000 - $430,000 = $710,000.
If comparable parades trade at an 8% capitalisation rate, the implied value is $710,000 / 0.08 = $8,875,000. Cutting $30,000 of annual running costs would lift NOI to $740,000 and implied value to $9,250,000.Case study
Seen in the real world.
This illustrative story features Cedarmark Estates, a fictional owner of three suburban office parks. Occupancy looked healthy at 92%, but NOI had drifted down for six straight quarters while rents were rising, which made no sense to the board.
An asset manager rebuilt the NOI line by line and found the problem sat in operating expenses. Service charge recoveries had not been updated after two tenants moved to a fixed cap, leaving Cedarmark absorbing about $180,000 a year of common area costs, and a grounds maintenance contract had been renewed on autopilot at well above market rate.
Resetting the recoveries at the next rent reviews and retendering the maintenance contract added roughly $240,000 to annual NOI. At the 7.5% capitalisation rate used by the valuer, that translated into about $3,200,000 of additional appraised value across the portfolio, with no new tenants and no building work.
Watch out
Common mistakes.
- Subtracting mortgage interest from NOI, which mixes the performance of the asset with the way the owner chose to fund it.
- Treating NOI as spendable cash and forgetting the roof replacement, loan repayments and tax that still have to be paid out of it.
- Using gross potential rent instead of effective gross income, which quietly assumes the building is always fully let and every tenant always pays.
Questions
People also ask.
Is NOI the same as EBITDA?
They are close cousins, but EBITDA is a whole-company measure while NOI is normally applied to a property or a single operating asset.
Should capital expenditure be deducted from NOI?
No, major works such as a new lift or roof sit below NOI, though many owners deduct a small annual reserve when modelling cash flow.
How does NOI connect to value?
Dividing NOI by the market capitalisation rate gives an estimated value, so a rise in NOI or a fall in the capitalisation rate both push the price up.
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