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Model Assumptions
- Single-period analysis: Annual income and expenses only
- Vacancy applies to all income: Both rental and other income are reduced by the vacancy rate
- Management fee on EGI: Calculated as a percentage of Effective Gross Income (industry standard)
- Excludes: Debt service, capital expenditures, depreciation, income taxes, and replacement reserves
For educational purposes. Not financial advice. Market conventions simplified.
NOI Waterfall
Potential Gross Income (PGI)
$525,000
Vacancy Loss (5.0%)
-$26,250
Effective Gross Income (EGI)
$498,750
Total Operating Expenses
-$159,938
Net Operating Income (NOI)
$338,813
EGI - Total Operating Expenses
Operating Expense Ratio
32.1%
Management Fee ($)
$24,938
Totals computed from unrounded values; displayed amounts may differ by $1 due to rounding.
Formula Breakdown
NOI = EGI - Total Operating Expenses
Where EGI = PGI - Vacancy Loss, and PGI = Rental Income + Other Income
OER Benchmarks
| OER Range | Rating | Interpretation |
|---|---|---|
| < 40% | Efficient | Low expense ratio relative to income |
| 40% – 60% | Typical | Average for most commercial properties |
| > 60% | High | May indicate expense management issues |
OER varies by property type and market. NNN-leased properties typically have lower OERs because tenants pay many expenses. Full-service gross-leased properties have higher OERs. Always compare to similar properties in your submarket.
Understanding Net Operating Income
What is Net Operating Income (NOI)?
Net Operating Income (NOI) is the annual income generated by a property after deducting operating expenses, but before debt service, capital expenditures, and income taxes. It is the most important property-level performance metric in commercial real estate.
NOI Waterfall
PGI = Gross Rental Income + Other Income
EGI = PGI - Vacancy Loss
NOI = EGI - Total Operating Expenses
OER = Total Operating Expenses / EGI
EGI = PGI - Vacancy Loss
NOI = EGI - Total Operating Expenses
OER = Total Operating Expenses / EGI
The NOI Waterfall Explained
NOI is calculated through a waterfall that systematically deducts losses and expenses from potential income:
- Potential Gross Income (PGI): Total rental income at full occupancy, plus other income sources (parking, laundry, storage)
- Vacancy & Credit Loss: Deduct expected vacancy and uncollectable rents
- Effective Gross Income (EGI): The realistic income the property will generate
- Operating Expenses: Deduct property taxes, insurance, maintenance, management, utilities, and other operating costs
- Net Operating Income (NOI): The property's operating profit before financing
What to Exclude from Operating Expenses
Critical: Do NOT include these items in operating expenses when calculating NOI:
- Debt service (mortgage payments) — financing cost, not an operating expense
- Capital expenditures (roof replacement, HVAC systems) — investment, not routine maintenance
- Depreciation — accounting convention, not a cash expense
- Income taxes — vary by owner, not by property
Note: Some analysts deduct replacement reserves from NOI. This calculator uses NOI before reserves.
Operating Expense Ratio (OER)
The Operating Expense Ratio (OER = Total Operating Expenses / EGI) measures what share of effective income goes to operating costs. Lower OER means more income flows through to NOI.
- Below 40%: Generally considered efficient
- 40% – 60%: Typical range for most commercial properties
- Above 60%: May indicate high expenses or below-market rents
Practical Applications of NOI
- Property Valuation: NOI / Cap Rate = Property Value
- Loan Underwriting: NOI / Debt Service = DSCR
- Investment Comparison: Compare operating performance across properties independent of financing
- Expense Benchmarking: OER identifies properties with unusually high operating costs
Key Insight: NOI is financing-neutral. Two investors buying the same property with different loan structures will have different cash flows but identical NOI. This makes NOI ideal for comparing properties on their operating merits.
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Frequently Asked Questions
NOI includes all revenue from the property (rental income, parking, laundry, late fees) minus operating expenses (property taxes, insurance, maintenance, utilities, management fees). NOI is calculated before debt service, capital expenditures, depreciation, and income taxes.
NOI excludes debt service (mortgage payments), capital expenditures (major repairs and improvements), depreciation, income taxes, tenant improvements, and leasing commissions. Some analysts also deduct replacement reserves from NOI. This calculator uses NOI before reserves. These items are below the NOI line and affect cash flow or taxable income, not operating performance.
There is no universal "good" NOI — it depends on property size, type, location, and purchase price. A more useful metric is the Operating Expense Ratio (OER): below 40% is generally efficient, 40–60% is typical, and above 60% may indicate high expenses relative to income. NOI is most useful when divided by property value to calculate the cap rate.
NOI measures property-level operating performance before financing costs and capital expenditures. Property Before-Tax Cash Flow (PBTCF) subtracts debt service and capital expenditures from NOI. A property can have positive NOI but negative cash flow if debt payments and capital spending are high. NOI is financing-neutral and useful for comparing properties regardless of how they are financed.
No. NOI is a property-level real estate operating metric with CRE-specific line-item conventions (PGI, vacancy, operating expenses). EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) is a company-level corporate finance metric that may include revenue from multiple sources and business operations. While both exclude financing costs and taxes, they serve different analytical purposes.
NOI is the numerator in the cap rate formula: Cap Rate = NOI / Property Value, or equivalently, Property Value = NOI / Cap Rate. If a property generates $338,813 in NOI and the market cap rate is 7%, the implied value is $338,813 / 0.07 ≈ $4,840,186. Use our Cap Rate Calculator for this analysis.
Disclaimer
This calculator is for educational purposes only. NOI analysis is one component of real estate investment evaluation. Actual investment decisions should consider additional factors including market trends, property condition, tenant quality, lease terms, financing costs, capital expenditure needs, and local economic conditions. Consult a qualified real estate professional or financial advisor for investment decisions.
