Net Operating Income (NOI)

Net operating income is rent less vacancy and operating costs. It is measured ahead of loan payments, depreciation and income tax. It is the starting point of the cash on cash numerator: cash flow equals NOI minus debt service. Cap rate divides the same NOI by price.

The operating costs are taxes, insurance, management, repairs, reserves for big-ticket items, any utilities the owner pays and HOA dues. They exclude principal, interest and improvements. On $5,200 of rent with 5% vacancy, $8,400 of taxes and insurance, and 18% of collected rent for the rest, NOI is $40,210.

Every point of cash on cash return traces back to a line in NOI. Omitting management adds about 3 points on the default deal; omitting reserves about 2; omitting vacancy about 1.7. A return that looks good only because the NOI is missing expenses is not a good return. On Wikipedia, a search for net operating income lands on the EBIT article, which is the corporate version of the same idea.