Net Operating Income (NOI) is the single most important number in rental property analysis. Every other metric you will ever use — cap rate, debt service coverage, cash-on-cash return, even the value an appraiser assigns to a small multifamily building — is derived from NOI. Calculate it wrong and every decision downstream is wrong.
The NOI Formula
- NOI = Effective Gross Income (EGI) − Operating Expenses
Where:
- Gross Scheduled Income (GSI): all rent if every unit were occupied 100% of the year, plus other income (laundry, parking, storage)
- Vacancy & credit loss: GSI × vacancy rate (5-10% is typical for small residential)
- EGI: GSI − vacancy loss
- Operating expenses: everything required to run the property — but not the mortgage
Step-by-Step: $450,000 Duplex
Income:
| Item | Annual |
|---|---|
| Unit 1 rent ($1,600 × 12) | $19,200 |
| Unit 2 rent ($1,500 × 12) | $18,000 |
| Laundry + storage income | $1,200 |
| Gross Scheduled Income | $38,400 |
| Vacancy (6%) | −$2,304 |
| Effective Gross Income | $36,096 |
Operating expenses:
| Item | Annual |
|---|---|
| Property taxes | $4,800 |
| Landlord insurance | $2,100 |
| Water/sewer + trash | $2,400 |
| Common area electric | $600 |
| Repairs & maintenance (8% of GSI) | $3,072 |
| CapEx reserves (8% of GSI) | $3,072 |
| Property management (8% of EGI) | $2,888 |
| Total OpEx | $18,932 |
NOI = $36,096 − $18,932 = $17,164/year
What Does NOT Belong in NOI
New investors routinely corrupt NOI by including:
- Mortgage principal and interest — debt service is a financing cost, not an operating cost. This is why NOI measures the property, not the deal.
- Income taxes — investor-specific, not property-specific.
- Capital expenditures as one-time hits — a new roof is lumpy, which is why we instead reserve a steady percentage (see our CapEx budgeting guide).
- Owner's car, travel, or "mileage" — only legitimate business expenses count.
- Depreciation — a paper expense for taxes, not cash operations.
Why NOI Matters So Much
1. Valuation
Small multifamily properties (2-4 units) sell on a blend of comps and income, but 5+ unit buildings sell almost purely on income: Value = NOI ÷ Cap Rate. If your duplex NOI is $17,164 and local cap rates are 6%, the income approach supports roughly $286,000 — a useful reality check against the asking price.
2. Debt Service Coverage
DSCR lenders require NOI (or gross rent, depending on program) to cover the payment. NOI of $17,164 against $13,000 of annual debt service is a 1.32 DSCR — approvable at prime rates.
3. Comparing Deals Fairly
Because NOI excludes financing, two properties with different loan structures can be compared apples-to-apples. The deal with the higher NOI relative to price is producing more income per dollar invested.
Separate Meters Change the Math
If tenants pay their own heat and electric (separate meters), your operating expense load drops by 3-6 percentage points of GSI compared to a master-metered building where the owner pays utilities. A master-metered duplex at the same price is worth meaningfully less — always adjust your offer.
Run Your Own Numbers
Our Multifamily Cash Flow & NOI Calculator walks through unit-by-unit rents, vacancy, reserves, and expenses to produce GSI, EGI, NOI, cap rate, and cash-on-cash return instantly — with the same structure lenders and appraisers use.