Vacancy takes $1,560 and operating costs take $9,800 — a 33% expense ratio
Gross rent of $30,000 plus $1,200 of other income gives $31,200. A 5% vacancy allowance removes $1,560, leaving effective gross income of $29,640. Operating expenses of $9,800 across tax, insurance, management, maintenance, utilities and other leave NOI of $19,840, which against a $350,000 price is a 5.67% cap rate.
NOI = (gross + other income) x (1 - vacancy) - operating expenses ; Cap rate = NOI / price
The expense ratio of 33.06% is the figure to sanity-check. Residential rentals commonly run 35-50% once management and honest maintenance reserves are included; anything reported well below 30% usually means a cost has been left out or reclassified as capital.
Mortgage payments, depreciation and capital works
NOI measures the building, not the deal. Mortgage interest and principal are excluded because they belong to whoever bought it rather than to the property. Depreciation is excluded because it is an accounting entry rather than cash. Capital expenditure — a new roof, a boiler replacement — is excluded because it is investment rather than operation.
That last exclusion is where NOI is most often flattered. A property needing $4,000 a year of major works still shows a clean NOI if those are booked as capital, and two sellers can present the same building at very different cap rates purely through classification. The maintenance line you enter is the one that decides whether this figure is honest.
Even a well-run single-family rental turns over
A 5% vacancy allowance is about eighteen days a year, which is optimistic for a single unit where one tenant change can mean a month empty. Multi-unit properties tend to average better because the turnover is spread; a single house is either fully let or fully empty.
Leaving vacancy at zero overstates NOI by the full allowance and, at a 5.67% cap rate, overstates implied value by a similar proportion. It is the single easiest line to omit and the one most likely to make a marginal deal look workable.
One year, at today’s rents, with no growth and no exit
NOI is a snapshot of one period. It says nothing about whether the leases in place are above or below market, whether rents in the area are rising, or what the building will sell for. A 5.67% cap rate on a property with rents 20% under market is a different investment from the same yield at market rent.
It also assumes the expense figures are complete and current. Property tax reassessment after a sale is a common surprise in jurisdictions that reassess on transfer, and insurance in several markets has risen faster than any other line. Verify both against actual bills rather than the seller’s figures.
Frequently Asked Questions
What is net operating income?
NOI is a property’s annual income after operating expenses but before the mortgage, income tax, and capital expenditure. It measures the profit the asset produces from operations, independent of how it is financed, which is why it is central to valuation.
Does NOI include the mortgage?
No. NOI deliberately excludes debt service so it reflects the property itself, not your particular loan. Subtracting the mortgage from NOI gives cash flow, which is a separate figure that depends on financing.
What is a good operating expense ratio?
For many residential rentals it falls roughly between 35% and 50% of effective gross income, though it varies by property type, age, and who pays utilities. A very low ratio may mean expenses are understated; a very high one warrants a closer look.
How does NOI relate to cap rate?
Cap rate is NOI divided by price or value. So NOI is the numerator of the cap rate and the basis for income-approach valuation: at a given market cap rate, a higher NOI directly implies a higher property value.
Should capital expenditure be in NOI?
Conventionally no; large, infrequent items like a new roof are treated as capital expenditure, separate from operating expenses. Some investors deduct a CapEx reserve to be conservative, but the standard NOI definition excludes it.
Why subtract a vacancy allowance?
Because no property stays fully occupied and fully paid forever. Applying a vacancy allowance turns scheduled rent into the income you realistically collect, so NOI reflects reality rather than a best case.
Sources & References
Figures on this page are checked against primary, authoritative sources. Links open in a new tab.
Returns are assumptions, not guarantees. Actual results may vary because of market performance, taxes, fees, inflation, and timing. This is an educational projection, not investment advice.
Published the calculator with its formula, worked example, assumptions, limitations and a bespoke guide, and added an automated formula test suite covering it.
Verified that every expense line reduces NOI and that the implied cap rate is NOI over the price, so the two figures cannot drift apart.
Frequently Asked Questions now show on the page: 6 answers, checked in a page-by-page audit.
What the calculation assumes and where it stops now show on the page.
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