I realize I have previously written about cap rate and cash-on-cash assuming prior knowledge of the basic building block of both, the Net Operating Income. So in order to be a little bit more canonical, let’s first grab this central piece for many other metrics to be understood.

Net Operating Income

NOI is a foundational metric from where several others are derived. It shows the income a property produces after financing or taxes come into play, measuring the money flow a property generates. The formula can be calculated monthly or annually but then all the elements have to use the corresponding equivalent.

It is structured in three “tiers”, where each incremental group has a name:

Monthly Rent + Other Income is called the Gross Potential Income (GPI), so the NOI reads as this:

Subtracting the Vacancy Loss - Credit Loss - Concessions group to the GPI yields the Effective Gross Income (EGI), thus:

NOI ignores depreciation, but it also ignores appreciation. It is about what you expect the property to earn from renting it, a reflection of the analyst’s opinions. A closer metric is Cashflow, which measures, oh surprise, the cash flow after financing and taxes are taken into account.

The rundown

Rent

Either measured monthly or annually, there are still two ways rent can be written down:

• Actual: what the property is being rented for at the moment if the property is for sale and having a tenant inside. The analyst does not have to invent anything.
• Market: what the property could be rented for provided we assume market rates of comparable properties. The property might be renting for a lower amount than the actual market rates and the analyst takes this into account.

Other income

There might be additional income from the rental of the property in the form of laundry fees, parking space, storage, pet fees, etc.. Now, here in Spain cases where an appartment is rented in a pack of appartment plus parking space can happen, but I haven’t seen that often. Same with additional laundry or storage, it might be more common in the US than here.

Vacancy Loss

It accounts for the rent loss of unoccupied units, and it’s measured as a percentage. Typical assumptions run within the 5% - 8% range for residential market. In Spain the normal range flows between 3% - 5%, being as low as 2% in big cities like Madrid or Barcelona. Based on what people have been telling me for awhile (so a very small sample set), it is not exceptional to list a new property in idealista and within the first 24 hours have a flood of applications to choose from. Spain has a wide territory but the population centers are deeply concentrated.

On top of that, we have a long standing housing crisis that contributes to a very low vacancy rate in the cities where the labor is most available, e.g. rental supply is down 61% in Spain since 2020. This is not an isolated phenomenon, it happens all over the world. Zooming in, rental supply in a big city like Barcelona has chilling numbers: 90% drop in rental supply, 63% increase in prices, 10x more competition per property. This contributes to a very low vacancy rate.

Credit Loss

Rent that was billed and never collected. The current trend in Spain is that this figure is increasing, due to a mix of bad market conditions, insufficient housing stock, and the concentration of highest paying jobs and good opportunities in main cities. Galicia, the region where I’m from, saw a +16.8% increase from 2024 to 2025, while in cities like Barcelona it saw a huge +38.3% jump.

Operational Expenses (OpEx)

There’s a lot of things that might count as an operating expense, but the general rule of thumb is to think of them as all the necessary costs that are necessary to keep the property running, and whether they incur in a recurring basis. The clear things that are left out are all the expenses directly related to the financing of the property, like personal taxes, mortgage principal or interest for example. Here’s a table with a more structured list of what does count as OpEx:

I am not sure about the Licenses & permits one. Normally I would associate those to a one-off expense when you want to clear your property for availability to rent, but not as a recurring one. And IMHO, in Spain there are no fees for rental properties which are the ones I have the minimal idea about. It will be different for commercial I’m sure, especially for those buildings that are constructed with a business in mind.

The noise in the NOI’s

There are four cases where how the NOI is calculated is subject to interpretation, and depending on which position you take, it will affect your final number and carry the assumption to all the other metrics that depend on it.

• Management fee when the owner self-manages: buying a property an hiring a property manager hits the NOI with an average 8% fee. If you are the one who self-manages the property, the fee is effectively none. Lenders and appraisers impute a management fee regardless of who manages the property, so the argument is to always add a percentage even if it is symbolic.

  The rationale is to pin your management fee as the living wage you earn to do it, but my personal take is not do it, and assume your living wage is the return on the income the property generates. If you self-manage and have an additional day job, maybe slap a petty % on it?

• Deduct reserves for CapEx versus not: this is the case where for this kind of analysis, capital expenditures are split and carried over a number of years and accounted for as operating expenses. Say you have a big roof replacement every 25 years that incurs into a big expense. Instead of happily showing an inflated NOI for that period of time and in year 25 writing off the roof replacement as a huge expense (that you won’t be able to deduct entirely either ways), you estimate the cost of the replacement, divide it by 25 and deduct the amount from the NOI as a reserve from the big hit you know is coming.

  This reserve of funds that are carried over the period of time are not pure operating expenses and you won’t be able to deduct them from tax purposes, but rather serve as an estimate to put that money aside in a savings account so when the big expense comes, the money is already available. It effectively decreases the NOI by baking this one-off big invesments into the life of the property rental.

  As I imagine it, is hard to know how much a roof replacement will cost in 25 years from now, because material prices and labor cost can’t be perfectly forecasted, but it paints a more honest picture of the actual income generating power of the property. You care about this especially if you’re buying for yourself.

• Tenant improvements: this is especially catered towards commercial real estate. For office buildings or ground-floor commercial premises, before a tenant moves their business into the office, the landlord has to prepare the space: painting, walls, new layout, etc. This materializes into an upfront cost that is not reflected in the NOI unless the analyst explicitly takes that into account.

  The particular case for Spain is that I have not known a case where the landlord actually assumes this, and when a tenant leases commercial space, they are in charge of assuming the costs of renovations and preparing.

• Non-recurring and extraordinary items: yes, you can try to account for reparations after an earthquake if you want to go into as much detail as possible.

Example

Easiest example, an appartment selling at €100,000, rented at €1000/month. For this case as it happens in Spain, the tenant pays for the utilities.

€12,000  GROSS POTENTIAL RENT ............ €1,000/mo × 12
    │
    └─    (600)  Vacancy Loss @ 5% ........ ~18 vacant days/yr
    │
    ▼
€11,400  EFFECTIVE GROSS INCOME
    │
    ├─  (1,200)  Property Taxes ........... 1.2% of €100,000
    ├─    (900)  Insurance ................
    ├─  (1,200)  Repairs & Maintenance .... €100/mo
    ├─    (900)  Management Fee ........... ~8% of EGI
    ├─  (1,200)  Replacement Reserves ..... €100/mo
    │            ─────────────────────────
    └─  (5,400)  Total Operating Expenses
    │
    ▼
 €6,000  NET OPERATING INCOME

One final caveat

The simple formula is most defensible when NOI is stabilized and sustainable and the property is relatively mature. For a development, rapidly growing property, or asset with substantial changes in future NOI, a DCF is generally more appropriate because the assumption of a constant income stream is too simplistic.

More metrics

There are several other metrics that depend on the NOI and that I will hopefully cover at some point:

NOI ─┬─→ Cap Rate           = NOI ÷ Value
     ├─→ Value              = NOI ÷ Cap Rate
     ├─→ DSCR               = NOI ÷ Annual Debt Service
     ├─→ Debt Yield         = NOI ÷ Loan Amount
     ├─→ Cash Flow          = NOI − Debt Service − CapEx
     ├─→ Cash-on-Cash       = Cash Flow ÷ Cash Invested
     └─→ IRR / Equity Multiple  (via projected NOI streams + exit value)

Have fun!