What is net operating income (NOI) derived from?

Net operating income (NOI) is a critical measure in real estate that reflects the income generated by a property after accounting for all operating expenses, but before deducting financing costs and taxes. The correct calculation for NOI is derived by taking potential gross income and subtracting operating expenses; however, it is essential to also take into account capital expenditures that are necessary for maintaining the property.

This makes the option of subtracting both operating expenses and necessary capital expenditures from potential gross income the best representation of how NOI is calculated. Capital expenditures are significant as they represent the funds required for repair or improvement that enhance the property's value or extend its useful life, and they are not considered as operational expenses in the traditional sense.

In contrast, the other choices do not fully capture the components that contribute to the net operating income. For example, effective gross income minus vacancy and collection loss only accounts for reduced income without factoring in all relevant expenses tied to the property's operational viability. Similarly, considering taxes in the calculation breaks the principle of NOI, which is defined before the impact of taxes is applied. Thus, recognizing both operating expenses and capital expenditures is crucial for an accurate representation of a property’s profitability through net operating income.