CRE glossary
Net Operating Income (NOI)
Net Operating Income (NOI) is a property's annual income after operating expenses but before debt service, capital expenditures, income taxes, and depreciation. It measures the cash a property generates from operations regardless of how it is financed.
Formula
NOI = Effective Gross Income − Operating Expenses (where Effective Gross Income = Gross Potential Rent + Other Income − Vacancy & Credit Loss)
How NOI is used in CRE underwriting
NOI is the single most important line in commercial real estate valuation because it is the numerator (or denominator) in nearly every core metric. Divide NOI by the cap rate to estimate value; divide it by property value to solve the cap rate; divide it by annual debt service to get DSCR; and divide it by total project cost to get yield on cost. Because NOI excludes financing and taxes, it lets investors compare two properties on equal operating footing even when their loan structures differ completely.
- •Value = NOI ÷ Cap Rate — the direct-capitalization approach to appraisal
- •DSCR = NOI ÷ Annual Debt Service — how lenders size loans
- •Debt Yield = NOI ÷ Loan Amount — a lender's leverage-independent risk check
- •Cap Rate = NOI ÷ Purchase Price — going-in yield on an all-cash basis
What NOI includes and excludes
NOI starts from Effective Gross Income (EGI) — gross potential rent plus other income (parking, laundry, RUBS reimbursements, storage) minus vacancy and credit loss — then subtracts operating expenses required to run the asset. Operating expenses include property taxes, insurance, property management, utilities, repairs and maintenance, payroll, and general/administrative costs. Critically, four categories sit below the NOI line and are excluded: debt service (principal and interest), capital expenditures and tenant improvements/leasing commissions, income taxes, and depreciation/amortization. Excluding these is what makes NOI a capital-structure-neutral measure of operating performance.
- •Included: EGI less property taxes, insurance, management, utilities, R&M, payroll, G&A
- •Excluded: debt service, CapEx, TI/LC, income tax, depreciation
- •EGI = Gross Potential Rent + Other Income − Vacancy & Credit Loss
Common pitfalls and manipulation
NOI is easy to inflate, and offering memoranda routinely present a rosy version. The most common trick is showing a pro-forma or 'stabilized' NOI built on below-market vacancy assumptions and above-market rents rather than the trailing-12-month (T-12) actuals. Sellers also frequently omit a management fee (assuming self-management), understate reserves, or bury recurring maintenance in CapEx to lift NOI. Because value moves inversely with cap rate, a $100,000 NOI overstatement at a 5.5% cap rate inflates value by roughly $1.8 million. Always reconcile the seller's stated NOI to the actual T-12 and rent roll, add a market-rate management fee, and underwrite an economic vacancy that reflects the market — not the broker's assumption.
Worked example
A 100-unit multifamily property rents at $1,500/month, giving Gross Potential Rent of $1,800,000/year. Add $60,000 of other income (parking, laundry). Subtract 5% vacancy and credit loss (−$93,000) for Effective Gross Income of $1,767,000. Operating expenses total $795,000 (property taxes $220,000, insurance $60,000, management at 3% $53,000, utilities $95,000, R&M $130,000, payroll $180,000, G&A $57,000). NOI = $1,767,000 − $795,000 = $972,000. At a 5.5% cap rate, that implies a value of $972,000 ÷ 0.055 ≈ $17.67 million. Note debt service and CapEx are not subtracted — they fall below the NOI line.
Frequently asked questions
- What is a good Net Operating Income (NOI)?
- There is no universal 'good' NOI figure because it scales with property size — a stabilized garden apartment complex and a single retail pad will have very different NOIs. What matters is NOI relative to price (the cap rate) and relative to debt (DSCR and debt yield), and whether NOI is trending up year over year. A rising NOI driven by real rent growth and expense control — not by deferring maintenance — is the sign of a healthy asset.
- Is NOI calculated before or after debt service?
- Before. NOI is calculated before (above) debt service, and it also excludes capital expenditures, income taxes, and depreciation. Subtracting debt service from NOI gives you cash flow before taxes (pre-tax cash flow), which is the figure used for cash-on-cash return. Keeping debt out of NOI is what allows two identical buildings with different loans to be compared fairly.
- What is the difference between NOI and cash flow?
- NOI measures operating performance before financing and capital; cash flow is what's left for the equity investor after those items. Starting from NOI, you subtract annual debt service and capital expenditures (and TI/LC for commercial leases) to arrive at the pre-tax cash flow the owner actually pockets. A property can have strong positive NOI yet negative cash flow if it is highly leveraged or facing heavy CapEx.
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