Net Operating Income (NOI)

Net operating income is a property's rental income after vacancy and operating expenses, before any mortgage payment, depreciation or income tax. It is the numerator of the cap rate. Divide NOI by price and you have the cap rate; divide it by a market cap rate and you have value.

Operating expenses include property taxes, insurance, management, maintenance, capital reserves, owner-paid utilities and association dues. They exclude principal, interest and improvements that add value. On a $500,000 rental at $4,000 rent with 5% vacancy and typical expenses, NOI is about $28,892, a 5.8% cap rate.

Every disagreement about a cap rate is usually a disagreement about NOI. Seller pro formas leave out management, reserves and vacancy and show a higher number. Rebuild it yourself before trusting any cap rate. The Wikipedia article on net operating income redirects to earnings before interest and taxes, the corporate version of the same measure.

Further reading: Net Operating Income (NOI) on Wikipedia.