Net operating income is what a property earns after operating expenses and before financing: effective gross income minus operating expenses, measured before debt service, capital expenditure, depreciation and income tax.
It exists to describe the building rather than its owner. Two identical warehouses across the street from each other should report the same NOI even if one is owned outright and the other carries debt at eight percent, because the debt is a fact about the buyer, not about the asset.
What goes into it
Start from effective gross income: scheduled base rent, plus recoveries and expense reimbursements, plus other income such as parking, storage, antenna or signage, minus vacancy and credit loss. Potential rent at full occupancy is not a starting point anyone should accept without seeing the vacancy assumption next to it.
Then subtract operating expenses: property taxes, insurance, utilities not recovered from tenants, repairs and maintenance, management fees, payroll for on-site staff, and common area costs.
What stays out, and why
Four exclusions are conventional, and the reason behind all four is the same: they describe the owner or the financing, not the asset.
- Mortgage principal and interest. A fact about the buyer.
- Capital expenditure. A new roof is not a cost of operating this year.
- Depreciation and amortisation. Accounting entries, not cash.
- Income tax. A fact about the owner's tax position.
Where two honest people disagree
Tenant improvements and leasing commissions. Many institutional models place both below the NOI line as capital items; others treat them as an operating cost of keeping the building leased. Both conventions are defensible and the two results are not comparable. Whenever an NOI is quoted without stating which convention produced it, that is the first question to ask.
Management fee. An owner-managed building often shows no management fee at all, which flatters NOI against a third-party-managed comparable. A market management fee is usually imputed for exactly this reason.
Reserves. A replacement reserve is a forward-looking allowance rather than a cost incurred. Whether it sits above or below the line varies by model.
Why the definition decides the value
The income approach divides NOI by a capitalisation rate. That means the relationship is proportional: an NOI overstated by five percent produces a value overstated by five percent, before anyone has argued about the cap rate at all. Most disputes that look like disagreements about the cap rate turn out, on inspection, to be disagreements about what went into the numerator.
This is why a value opinion is only as good as the trail behind each line of its income statement. A figure you cannot follow back to a lease, a bill or a filing is a figure someone chose.