The formula
NOI = Gross Potential Rent − Vacancy and Credit Losses − Operating Expenses. Operating expenses include property taxes, insurance, property management fees, maintenance and repairs, utilities paid by the owner, and capital expenditure reserves. What is explicitly excluded from NOI: mortgage principal and interest, depreciation, income taxes, and capital improvements. NOI measures the property's performance independent of how it's financed.
How NOI is used
Cap rate = NOI ÷ Property Value. If a property generates $60,000 of NOI and sells for $1,000,000, the cap rate is 6%. Cap rate lets investors compare properties on a financing-agnostic basis — a useful metric when market participants pay cash or use similar leverage.
Valuation: commercial property is often valued by dividing expected NOI by a market cap rate (the income approach). A building with $100,000 NOI in a 5-cap market is worth about $2,000,000. Changes in NOI directly affect value, which is why adding a unit or raising rents has an outsized impact on a building's sale price.
NOI vs. cash flow
NOI is not the same as cash flow. Cash flow subtracts debt service (mortgage principal and interest) from NOI. A property with $60,000 NOI and $48,000 in annual mortgage payments generates $12,000 in annual pre-tax cash flow. Using cash-on-cash return, that $12,000 is divided by total cash invested (down payment, closing costs, renovations) to measure the return on equity.
Frequently asked questions
Does NOI include mortgage payments?
No. NOI is calculated before debt service. It measures the property's income independent of financing. Subtract mortgage principal and interest from NOI to get pre-tax cash flow.
How is NOI used to value commercial property?
Divide the expected NOI by the market cap rate to estimate property value (income approach). Lower cap rates mean higher valuations for the same NOI.
What is the difference between NOI and cash flow?
NOI excludes debt service; cash flow subtracts it. A high-NOI property with heavy debt service may produce less cash flow than a lower-NOI property with less leverage.
Sources
Educational information and estimates only. Not tax advice. Tax rules change and vary by situation; consult a qualified tax professional before acting.