Net Operating Income (NOI)

Net operating income is the rental income a property keeps once vacancy and operating expenses are paid, counted before debt service, depreciation and income taxes. Cap rate uses it as the numerator. Divide NOI by price and you have the cap rate; divide it by a market cap rate and you have value.

Those expenses cover insurance, property taxes, management, maintenance, reserves for capital items, utilities the owner pays and association dues. They exclude principal, interest and improvements that add value. Take a $500,000 rental renting for $4,000 a month with 5% vacancy and typical expenses: NOI comes to 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. Wikipedia sends net operating income readers to its article on EBIT, short for earnings before interest and taxes, the corporate counterpart of the same measure.