How to Calculate Net Operating Income (NOI) for California Property
Net operating income (NOI) is a property’s yearly income after vacancy and operating expenses, before mortgage payments, depreciation and income taxes. To calculate it, start with the rent the property could collect, subtract vacancy and credit loss, add other income, then subtract the costs of running the property. Divide NOI by a market cap rate and you have an income-based estimate of value, which is why a few thousand dollars of NOI can move a price by tens of thousands.
The arithmetic is simple. The hard part is the inputs, and California has several that trip up buyers and sellers: property tax resets when a property sells, rent increases are capped on many units, and water billing to tenants follows specific statutes. This guide walks through NOI line by line, then shows a worked fourplex example. For how NOI becomes a value, see our cap rate guide; for the full underwriting process, our rental property analysis guide.
The NOI formula, line by line
| Line | What goes in it | Common mistake |
|---|---|---|
| Gross potential rent | Every unit at its current lease rent, with vacant units at market rent | Using asking rents for occupied units |
| Less vacancy and credit loss | Expected turnover, downtime and unpaid rent | Assuming zero because the building is full today |
| Plus other income | Laundry, parking, storage, permitted utility reimbursements, commercial expense reimbursements | Counting income the leases don’t support |
| = Effective gross income (EGI) | What the property should actually collect | |
| Less operating expenses | Property tax, insurance, owner-paid utilities, repairs and maintenance, management, landscaping, trash, licenses and fees, reserves | Leaving out management or using the seller’s old tax bill |
| = Net operating income | EGI minus operating expenses |
What NOI leaves out
- Debt service. Mortgage principal and interest come after NOI. That’s what lets you compare properties regardless of how each buyer finances.
- Depreciation and income taxes. These depend on the owner, not the property.
- Capital improvements. A new roof is a capital cost, not an operating expense. Many analysts instead deduct an annual replacement reserve so NOI reflects the wear that’s coming. Practice varies, so ask which method a broker’s or seller’s figure uses.
- Owner’s personal costs. Travel, the owner’s own vehicle and unrelated legal fees don’t belong in a property’s expenses.
California lines that change the number
Property tax resets at the sale
When a property changes ownership, Proposition 13 requires the county assessor to reassess it to current market value. Prop 13 limits the general tax to 1% of assessed value and annual assessment increases to no more than 2%, but the tax bill also carries voter-approved bond rates and any special taxes or direct assessments, including Mello-Roos where they apply. A seller who has owned for twenty years may be paying a fraction of what you will.
So underwrite the buyer’s tax: your expected price times the full rate on the current bill, plus the fixed charges. Expect a supplemental tax bill after closing as well. The Board of Equalization explains that a change in ownership triggers a supplemental assessment for the difference between the old and new values, billed separately from the annual bill. Our guide to California property tax for investors covers reassessment in more depth.
Rent growth is capped on many units
Under the state rent cap in Civil Code section 1947.12, increases on covered units over any 12 months can’t exceed 5% plus the change in the cost of living, or 10%, whichever is lower, and the section runs until January 1, 2030. Exemptions include housing with a certificate of occupancy issued in the previous 15 years and some owner-occupied duplexes, and local rent ordinances can be stricter. That limits how fast NOI can grow after purchase, so a pro forma that assumes rents jump to market in year one is not a real NOI. See our guide to AB 1482 for landlords.
Water billing to tenants follows statute
California’s water submetering law, Civil Code section 1954.201 and following, controls what a landlord may bill tenants for water through submeters. Before the lease is signed, the landlord must give a written disclosure that includes an estimated monthly bill. The bill may include only the tenant’s usage, calculated by a method the statute allows, a share of the water purveyor’s fixed charges, a billing fee capped at the lesser of $4.75 (adjustable for inflation since 2018) or 25% of the usage charge, and late fees allowed by section 1954.213. The statute also defines ratio utility billing (RUBS), which divides costs by square footage or occupancy. Before you count utility reimbursements as income, check that the leases provide for them and that the method complies with state law and any local rent ordinance.
Management, even if you self-manage
Include a market management fee even if you plan to manage the property yourself. Your time has a cost, and the next buyer or lender will deduct one. California’s property tax income-approach rule makes the same point in its own way: when income comes from operating a property, it excludes enough to compensate unpaid or underpaid management. If you’d rather hire out, see our page on property management in Sonoma County.
A worked example: an illustrative North Bay fourplex
The numbers below are hypothetical, chosen to show the method. They are not market data, and your rents, tax rate and costs will differ. Assume four units renting at $2,800 a month, a $1,500,000 purchase price and a combined tax rate of 1.1%.
| Line | Buyer’s NOI | How it was figured |
|---|---|---|
| Gross potential rent | $134,400 | 4 units x $2,800 x 12 |
| Vacancy and credit loss | -$4,032 | 3% of gross potential rent |
| Laundry income | +$1,800 | From the machine contract |
| Effective gross income | $132,168 | |
| Property tax | -$16,500 | 1.1% of the $1,500,000 price |
| Insurance | -$6,000 | Current quote |
| Water, sewer and trash | -$7,200 | Owner-paid, from 12 months of bills |
| Common-area electricity | -$1,200 | From utility bills |
| Repairs and maintenance | -$6,000 | $1,500 per unit |
| Management | -$7,930 | 6% of effective gross income |
| Landscaping | -$1,800 | Contract |
| Licenses, fees and admin | -$600 | Business license, bookkeeping |
| Replacement reserves | -$1,600 | $400 per unit |
| Total operating expenses | -$48,830 | About 37% of EGI |
| Net operating income | $83,338 |
Now compare a seller’s version of the same building: no vacancy allowance, the seller’s old tax bill of $4,000, no management fee because the seller self-manages, and no reserves. That version shows an NOI of $109,400. At an assumed 5% cap rate, used here only for illustration, the buyer’s NOI supports about $1,667,000 and the seller’s about $2,188,000. The gap of more than $500,000 comes entirely from how the expenses were stated, not from the building.
How to check a seller’s NOI
- Ask for the trailing 12 months (T-12) and a current rent roll. Use actual income and expense statements, not a pro forma.
- Tie income to the bank. Match rents on the roll to deposits, and confirm leases and deposits with tenant estoppel certificates.
- Reset the property tax. Replace the seller’s bill with your price times the current rate, plus fixed charges.
- Add what’s missing. Management, a vacancy allowance and reserves are the usual omissions.
- Normalize repairs. One unusually low or high year doesn’t represent the building. Look at two or three years if you can.
- Re-quote insurance. Use a current quote for your coverage, not the seller’s renewal.
- Check rent growth against the law. Apply the state cap or local ordinance before projecting increases.
Diamond may refer you to partners we work with, such as insurance brokers or property managers; you’re free to choose any provider.
NOI, loans and commercial leases
Lenders size income-property loans from NOI. The debt service coverage ratio is NOI divided by annual mortgage payments, and each lender sets its own minimum. Our guides to apartment building loans and DSCR loans explain how that works. Once you know the financing, our cash-on-cash return guide carries the analysis below the NOI line.
Commercial NOI depends heavily on the lease. Under a triple-net lease the tenant reimburses taxes, insurance and maintenance, so those costs appear as both expense and reimbursement, while a gross lease leaves them with the landlord. Read the reimbursement clauses, not just the rent; our overview of commercial lease types explains the differences, and our guide to valuing commercial property shows how appraisers use NOI with the other approaches.
The assessor’s NOI is different
If you ever appeal a property tax assessment, know that the assessor’s income approach doesn’t use the same NOI a buyer does. California Property Tax Rule 8 leaves depreciation, debt retirement and interest on funds invested in the property out of expenses, much as a buyer would. It also excludes property taxes themselves and adds a property tax component to the capitalization rate instead. Rule 8 says a cap rate derived from comparable sales is preferred when the data exist. Ask a tax adviser or appeals specialist before you compare your own NOI with the assessor’s.
Questions people ask
What is the formula for net operating income?
NOI equals effective gross income minus operating expenses. Effective gross income is gross potential rent, less vacancy and credit loss, plus other income.
Does NOI include the mortgage payment?
No. NOI is calculated before debt service. Lenders compare NOI with the mortgage payment to get the debt service coverage ratio.
Is property tax included in NOI?
Yes, for a buyer’s or lender’s NOI. In California, use the tax you’ll pay after the sale is reassessed, not the seller’s current bill. The assessor’s own income approach handles property tax differently, through the cap rate.
Are capital expenditures part of NOI?
Not directly. Capital improvements are excluded, but many analysts deduct an annual replacement reserve to account for future capital needs. Ask which method a quoted NOI uses.
What is a good NOI?
There’s no single good number. NOI only means something next to the price and the cap rates on comparable sales, and the same NOI can support very different values in different locations.
How is NOI different from cash flow?
Cash flow is what’s left after debt service and capital spending. Two buyers can have the same NOI and very different cash flow because they borrowed differently.
If you own an income property and want to know what its NOI supports in today’s market, or you’re comparing buildings to buy, we can rebuild the numbers with you. See how we help owners sell multifamily property, or start with our investment property services.
This is general information, not legal or tax advice; talk to a California CPA or tax adviser about your situation.
Sources & notes
- California State Board of Equalization: Change in ownership FAQs
- California State Board of Equalization: Supplemental assessments
- San Mateo County Assessor: Real property assessment and Proposition 13
- Cornell LII: California Code of Regulations, title 18, section 8 (Property Tax Rule 8, income approach)
- FindLaw: California Civil Code section 1947.12
- FindLaw: California Civil Code section 1954.202 (submetering definitions), section 1954.203, section 1954.204 and section 1954.205
The worked example uses hypothetical figures to show the method; it is not a market survey. Statute mirrors were used because the Legislature’s site was unreachable; confirm current text at leginfo.legislature.ca.gov.
Last reviewed October 2026 by Matthew Martinez.
