Updated · Part of the CRE investment glossary
How NOI works
NOI is the property-level profit line in commercial real estate. It starts with the rent the building could collect, subtracts vacancy and bad debt, adds other income, then subtracts the costs of running the property. What is left is the income available to pay lenders, fund capital projects and distribute to owners.
Because it sits above financing, two buyers with different loans see the same NOI. That is why appraisers and lenders anchor on it, and why sellers and buyers argue over every line.
Commercial property adds one wrinkle. Under net leases, tenants reimburse some or all of taxes, insurance and common-area costs. Those reimbursements count as income, so the same expense can appear on both sides of the statement. A vacant suite then costs the owner its rent and the expenses that tenant would have reimbursed.
The formula
Most operating statements build NOI in two steps:
NOI = effective gross income − operating expenses
- Effective gross income (EGI) = gross potential rent − vacancy and credit loss − concessions + other income.
- Other income: parking, laundry, storage, fees and, for commercial leases, expense reimbursements from tenants.
- Operating expenses: taxes, insurance, utilities, repairs and maintenance, payroll, property management and administration.
What is in NOI and what is not
The test is whether the cost is part of running the property in an ordinary year. These items are kept out of NOI:
- Debt service: mortgage principal and interest. It depends on the owner’s financing, not the building.
- Capital expenditures: roofs, HVAC replacements, unit renovations. Many underwriters show a replacement reserve, either inside or just below NOI — say which.
- Depreciation and amortization: non-cash accounting entries.
- Income taxes of the owner, and partnership or fund costs such as a sponsor’s asset management fee, which are usually paid below NOI.
- For commercial property, tenant improvements and leasing commissions are often shown below NOI as well.
Worked example: a 50-unit apartment building
Fifty units average $1,400 a month. The underwriter assumes 6% vacancy and credit loss and a property management fee of 4% of effective gross income.
The result is $468,576 of NOI and an expense ratio of about 43% of EGI. At a 6% cap rate, that NOI implies a value of $7,809,600. Loan payments and a planned roof replacement do not change this figure; they come out afterward.
| Line | Calculation | Amount |
|---|---|---|
| Gross potential rent | 50 × $1,400 × 12 | $840,000 |
| Vacancy and credit loss | 6% × $840,000 | −$50,400 |
| Other income | Parking, laundry, fees | $36,000 |
| Effective gross income | $840,000 − $50,400 + $36,000 | $825,600 |
| Property taxes | $105,000 | |
| Insurance | $42,000 | |
| Utilities | $58,000 | |
| Repairs and maintenance | $45,000 | |
| Payroll | $60,000 | |
| Management fee | 4% × $825,600 | $33,024 |
| Administrative and marketing | $14,000 | |
| Total operating expenses | Sum of the seven lines | $357,024 |
| Net operating income | $825,600 − $357,024 | $468,576 |
What to watch for
NOI is easy to inflate without changing a single rent:
- A seller’s statement with no management fee because the owner self-manages. A buyer will pay one.
- Property taxes at the seller’s assessed value when a sale may trigger a reassessment.
- Repairs booked as capital expenditures, or capital work booked as repairs, which moves cost in or out of NOI.
- One-time income, such as an insurance payout or a lease termination fee, left in the trailing figure.
General information, not legal, tax or investment advice. Your operating agreement, offering documents, counsel and CPA govern your deal.