What it is
Net operating income is what a property earns from operations once the bills are paid, before anyone pays the mortgage. It is the number almost every commercial real estate metric is built on: DSCR, debt yield, cap rate and value all start here.
How it's calculated
Start with gross potential rent, subtract vacancy and credit loss, add other income, then subtract operating expenses.
| Line | Amount |
|---|---|
| Gross potential rent | $2,000,000 |
| Less vacancy and credit loss (5%) | ($100,000) |
| Other income (parking, laundry, fees) | $60,000 |
| Effective gross income | $1,960,000 |
| Operating expenses | ($760,000) |
| Net operating income | $1,200,000 |
What stays out of NOI
- Debt service (principal and interest)
- Capital expenditures such as roof replacements or unit renovations
- Depreciation and amortization
- The owner's income taxes
Operating expenses that do belong in NOI include real estate taxes, insurance, utilities paid by the owner, repairs and maintenance, payroll, and management fees.
How lenders use it
Lenders never take the borrower's NOI at face value. They build their own, often called underwritten NOI, and it is usually lower. Typical adjustments:
- Vacancy. Lenders apply at least their minimum vacancy factor, even if the property is 100% leased today.
- Management fee. A self-managed property still gets a market fee, often a few percent of effective gross income.
- Real estate taxes. On an acquisition, lenders may reassess taxes at the purchase price.
- Reserves. Replacement reserves, and on office or retail, tenant improvements and leasing commissions, are often deducted to reach net cash flow.
- Above-market or expiring leases. Rent may be marked to market or vacancy assumed on near-term rollover.
Where NOI comes from
In-place NOI comes from the T-12 and the current rent roll. Projected NOI comes from a pro forma. Permanent lenders mostly underwrite in-place. Bridge and construction lenders look at both, because they are lending against a business plan. See how to read a rent roll and T-12 for the reconciliation lenders expect.
Common mistakes
- Counting one-time income. A lease termination fee is not recurring income.
- Leaving out the management fee or reserves. The lender will add them, and your NOI will shrink in their model.
- Mixing periods. Annualizing three strong months next to a twelve-month expense line inflates NOI.
In the package
Show NOI on a line-by-line basis, tie every number to its source document, and present your underwritten NOI with the adjustments a lender would make already applied. Dori extracts the T-12 and rent roll into your own underwriting model, with each figure linked back to the page it came from.