Net Operating Income (NOI) for Apartments: Formula and Example
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Net operating income (NOI) is an apartment building's effective gross income minus its operating expenses. It leaves out the loan payment, income taxes, depreciation and major capital projects, so it measures what the property itself earns before financing. NOI matters because value is estimated as NOI divided by a cap rate, lenders size loans from it, and distributions to investors come from the cash left after it. Sponsors who raise equity with DoorRaise are asked to show their NOI and how they built it.
This post gives the formula, lists what to include and exclude, shows a hypothetical example and explains how NOI can be inflated. It is the base for our underwriting basics guide.
What is the NOI formula?
- Start with gross potential rent (GPR).
- Subtract vacancy, loss to lease, concessions and bad debt.
- Add other income. The result is effective gross income (EGI).
- Subtract operating expenses. The result is NOI.
Value = NOI / cap rate. At a 7% cap rate, each $1,000 of NOI is worth about $14,286 of value. The same relationship cuts the other way: a $1,000 error in NOI is a $14,286 error in price at that rate.
What is included and what is not?
Included in income: rent, laundry, parking, pet fees, utility reimbursements, late fees, application fees and similar recurring items. See other income in underwriting.
Included in expenses: property taxes, insurance, repairs, turnover, utilities, management fee, payroll, administrative and marketing costs.
Excluded: mortgage principal and interest, depreciation, income taxes, sponsor fees, major capital projects and one-time items such as insurance claim proceeds.
A hypothetical example
This example is hypothetical, for illustration only. A 12-unit building has market rent of $1,000 a unit.
| Line | Annual amount |
|---|---|
| Gross potential rent (12 x $1,000 x 12) | $144,000 |
| Vacancy and credit loss at 6% | -$8,640 |
| Other income | +$3,600 |
| Effective gross income | $138,960 |
| Operating expenses | -$62,000 |
| NOI | $76,960 |
| Value at a 7% cap rate | about $1.10 million |
| Debt service (assumed) | -$48,000 |
| Reserves ($250 a unit) | -$3,000 |
| Cash flow after debt and reserves | $25,960 |
Notice that $76,960 of NOI becomes $25,960 of cash flow once the loan and reserves are paid. If expenses were 10% higher ($6,200), NOI falls to $70,760, cash flow to $19,760 and value at a 7% cap rate to about $1.01 million. Small errors in NOI become large errors in cash flow.
How can NOI be inflated?
- Leaving out the management fee because the owner runs the property
- Using last year's property taxes when a sale will reassess them. See property tax reassessment.
- Understating repairs by moving them into capital expenses
- Counting one-time income, such as a settlement or insurance proceeds, as recurring
- Using market rent for vacant or below-market units without proof. See loss to lease.
- Annualizing a strong month instead of using a full 12 months
Check each against the T-12 and the bank statements. Our rent roll and T-12 guide shows how.
How DoorRaise fits in
DoorRaise helps sponsors raise equity for apartment buildings with 5 or more units under Rule 506(b) or 506(c). It prepares the offering documents from the sponsor's inputs, coordinates escrow with Enterprise Bank & Trust, collects investor funds by wire only and handles filings. The deal page shows investors your business plan and projection assumptions. DoorRaise does not verify a seller's or a sponsor's numbers; sponsors must check what they present.
DoorRaise is for apartment buildings with 5 or more units, and sponsors can launch their deal here. Setup is $1,500 (non-refundable), and the administration fee is $5,000 a year from closing.
To get started, create your sponsor page or see the fees.
FAQ
What does NOI stand for?
Net operating income.
How do you calculate NOI for an apartment building?
Subtract operating expenses from effective gross income. Effective gross income is rent and other income after vacancy and rent losses.
Is the mortgage included in NOI?
No. Loan payments come after NOI.
Is depreciation part of NOI?
No. Depreciation is a tax item, not an operating expense.
Is NOI the same as cash flow?
No. Cash flow subtracts debt service, reserves and fees from NOI.
Why do lenders care about NOI?
They size loans using debt service coverage, which compares NOI with the loan payment. See multifamily DSCR loans.
Sources
- Fannie Mae, Multifamily fixed-rate mortgage loans
- 17 CFR 240.10b-5, Employment of manipulative and deceptive devices
This article is general information, not legal, tax or investment advice. Talk to a securities attorney and a CPA about your deal. DoorRaise is not a law firm, broker-dealer, investment adviser or funding portal.