Net operating income (or NOI) is a measure of an income property’s net income from all sources before allocations for debt service or tax (payments or savings) are calculated, and in turn, the NOI plays a large role in a variety of real estate investment and holding period decisions.

For example, market values are based on NOI, financing considerations are based on NOI, and investment decisions are based on this cash flow.

Net operating income is the amount of cash flow remaining after vacancy and all operating expenses are paid. Computed by deducting operating expenses from gross operating income (or GOI), net operating income is simply income less expenses.

Most important to the real estate investor, NOI represents the amount cash flow (or funds available) to pay the mortgage.

As a result, lenders are very interested in knowing a property’s net operating income in order to determine whether the property generates sufficient cash flow to cover the debt service. They use a return called debt coverage ratio (DCR) which is calculated by dividing the net operating income by the annual loan payment.

Although lenders normally require nothing less then 1.00 (indicating that the NOI is exactly equal to the loan payment), they typically require a more aggressive DCR in the range of about 1.20 (a higher NOI to loan payment ratio by 20%, or enough cash flow to service the payment with money to spare).

Those acquainted with real investing who have computed capitalization rate (or cap rate) will also recognize net operating income. The formula for capitalization rate is NOI divided by sale price.

Perhaps now with some insight about the cash flow net operating income represents, you can understand why cap rate has become such a popular return. Cap rate measures the percent of net operating income to price (or property value).