NOI Calculation for Commercial Real Estate

What Is Net Operating Income and Why Does It Matter?

Net operating income (NOI) is the single most important financial metric in commercial real estate. It represents the total income a property generates after subtracting all operating expenses, but before accounting for debt service, capital expenditures, and income taxes. Lenders, appraisers, and investors all rely on NOI to evaluate property performance, determine market value, and assess whether an asset can support financing.

The NOI calculation for commercial real estate follows a straightforward formula: Effective Gross Income minus Operating Expenses equals Net Operating Income. Despite this simplicity, the details of what to include, what to exclude, and how to handle each line item determine whether your analysis is accurate or misleading.

NOI serves as the foundation for three critical calculations. First, it determines property value through the capitalization rate formula (Value = NOI / Cap Rate). Second, it drives the debt service coverage ratio (DSCR), which lenders use to determine how much they will lend. Third, it establishes the baseline for cash flow projections that guide investment decisions. For a deeper look at how DSCR works alongside NOI, read our DSCR analysis guide.

How Do You Calculate NOI Step by Step?

The NOI calculation follows a six-step process that moves from gross potential income down to the final net operating income figure. Each step involves specific inputs and assumptions grounded in market data and actual property performance.

Step 1: Determine Gross Potential Income (GPI). Start with the total rental income the property would generate if every unit or space were leased at current market rates with zero vacancy. For a 20-unit apartment building where each unit rents for $2,000 per month, the GPI is $480,000 annually. For office or retail properties, multiply the leasable square footage by the market rent per square foot.

Step 2: Subtract Vacancy and Credit Loss. No commercial property maintains 100% occupancy at all times. Deduct a vacancy and credit loss factor, typically 5 to 10% of GPI depending on property type, location, and market conditions. Vacancy covers unleased space and downtime between tenants. Credit loss accounts for tenants who default on rent payments.

Step 3: Add Other Income. Include all non-rental revenue: parking fees, laundry income, storage rentals, late fees, application fees, pet rent, vending machines, and any other recurring ancillary income. For many multifamily properties, other income adds 3 to 7% on top of base rental income.

Step 4: Calculate Effective Gross Income (EGI). GPI minus vacancy and credit loss, plus other income, equals your effective gross income. This represents the realistic total revenue the property generates annually.

Step 5: Subtract All Operating Expenses. Deduct every recurring cost required to operate the property: property taxes, insurance, management fees, maintenance and repairs, utilities, landscaping, pest control, administrative costs, and reserves for replacement.

Step 6: The Result Is Your NOI. Effective gross income minus total operating expenses equals net operating income. This figure tells you how much income the property produces before financing costs and is the number lenders use to underwrite your loan. Use our commercial mortgage calculator to see how your NOI translates into borrowing capacity.

What Does a Complete NOI Calculation Look Like?

Seeing a full NOI calculation with real numbers makes the formula concrete. The following example walks through every line item for a 20-unit garden-style apartment building in a mid-sized market, purchased for $4.2 million.

In this example, the property generates $307,248 in NOI, representing an operating expense ratio of 33.8%. This means 33.8 cents of every dollar of effective gross income goes to operating expenses, while 66.2 cents flows to NOI. For multifamily properties, a 30 to 45% operating expense ratio is typical, with garden-style apartments on the lower end and high-rise buildings on the higher end.

To determine property value, divide NOI by the market cap rate. At a 7.0% cap rate, this property is worth approximately $4,389,257 ($307,248 / 0.07). To calculate DSCR, divide NOI by annual debt service. If the annual mortgage payment is $240,000, the DSCR is 1.28x ($307,248 / $240,000). Check your property's DSCR with our DSCR calculator.

For a related breakdown of cap rate mechanics, see our cap rate guide for commercial real estate.

What Is the Difference Between NOI and Cash Flow?

NOI and cash flow are related but distinct metrics. NOI measures property-level operating performance independent of how the asset is financed. Cash flow measures the actual money that reaches the investor after all obligations are paid. Confusing these two is one of the most common errors in commercial real estate analysis.

The formula for Before-Tax Cash Flow: NOI minus Debt Service minus Capital Expenditures minus Tenant Improvements minus Leasing Commissions equals Before-Tax Cash Flow.

Using the 20-unit apartment example: $307,248 NOI minus $240,000 debt service minus $15,000 capital expenditures equals $52,248 in before-tax cash flow. While the NOI looks healthy at $307,248, the actual cash returned to the investor is $52,248. On a $1,050,000 down payment (25% of $4.2M purchase price), that represents a 5.0% cash-on-cash return.

This distinction matters because two identical properties with the same NOI can produce vastly different cash flows depending on their financing. Lenders use NOI because it strips out financing variables and isolates the property's earning power. Investors should analyze both metrics to make informed decisions.

When evaluating a property for acquisition financing or refinancing, run both calculations. NOI tells you what the property is worth. Cash flow tells you what it puts in your pocket.

What Operating Expenses Should You Include in the NOI Calculation?

Operating expenses in a NOI calculation include every recurring cost necessary to maintain and operate the property. The key word is "recurring." One-time costs, capital improvements, and financing costs are excluded. Getting the expense categories right is critical because overstating expenses understates NOI, while understating expenses inflates NOI and can lead to overleveraging.

Property Taxes are typically the largest single expense, representing 25 to 35% of total operating costs. Always verify the current tax assessment and model any reassessment risk following a sale. Many jurisdictions reassess property taxes upon transfer, which can significantly increase this line item.

Insurance covers property, liability, and umbrella policies. Commercial property insurance costs $0.50 to $1.50 per square foot annually, depending on location, construction type, and coverage limits.

Property Management Fees range from 3 to 8% of effective gross income. Even if you self-manage, lenders require a management fee in your NOI calculation because a future owner may need professional management.

Maintenance and Repairs include routine upkeep: plumbing repairs, HVAC servicing, appliance replacements, painting, and general building maintenance. Budget $500 to $1,500 per unit annually for multifamily or $1 to $3 per square foot for commercial properties.

Utilities paid by the landlord include water, sewer, trash, common area electricity, and gas. In properties where tenants pay their own utilities, landlord costs are limited to common areas. For a detailed analysis of operating expense categories, read our operating expense analysis guide.

Reserves for Replacement fund future capital items like roof replacement, HVAC systems, parking lot resurfacing, and elevator modernization. Lenders typically require $250 to $500 per unit annually for multifamily or $0.15 to $0.30 per square foot for commercial properties.

What Items Should You Exclude from the NOI Calculation?

Knowing what to exclude from NOI is just as important as knowing what to include. Incorrectly adding debt service, capital expenditures, or non-recurring items will produce an inaccurate figure that misleads your analysis and may cause lender rejection.

Debt Service (Mortgage Payments): NOI is calculated before any financing costs. Principal and interest payments are not operating expenses. Different buyers use different leverage levels, so including debt service would make NOI incomparable across investors.

Capital Expenditures (CapEx): Major improvements like roof replacement ($50,000 to $150,000), HVAC system replacement ($5,000 to $15,000 per unit), or parking lot repaving are excluded. These are long-term investments that extend the useful life of the property. However, reserves for replacement (which fund future CapEx) are included as an operating expense.

Depreciation and Amortization: These are accounting entries, not actual cash expenses. Depreciation reduces taxable income but does not affect NOI.

Income Taxes: Personal or corporate income taxes on property earnings are investor-specific and excluded from NOI.

Tenant Improvements and Leasing Commissions: Build-out allowances ($20 to $60 per SF for office) and broker commissions (3 to 6% of total lease value) are capital costs excluded from NOI.

Loan Origination Fees and Closing Costs: One-time transaction costs related to acquiring or financing the property are not operating expenses.

What Is Stabilized NOI and How Do Lenders Calculate It?

Stabilized NOI represents the expected net operating income once a property reaches a normal, sustainable level of occupancy and market-rate rents. Lenders use stabilized NOI rather than trailing actuals when the property's current income does not reflect its true earning potential. This is common with value-add acquisitions, lease-up properties, or assets with below-market rents.

Lenders calculate stabilized NOI by making specific adjustments. They replace below-market rents with market-rate rents based on comparable properties. They apply a market vacancy factor (typically 5 to 10%) regardless of current occupancy. They add a management fee (usually 3 to 8% of EGI) even if the owner self-manages. They include reserves for replacement at $250 to $500 per unit per year. They also remove non-recurring income or expense items that distort the trailing 12-month numbers.

Example: Stabilizing a Value-Add Multifamily Property. A 30-unit apartment building currently generates $540,000 in gross rent at $1,500 per month average. Market rents for renovated units are $1,800 per month. After renovating all units, stabilized GPI becomes $648,000. Applying a 7% vacancy factor ($45,360), adding $24,000 in other income, and subtracting $230,000 in stabilized operating expenses produces a stabilized NOI of $396,640. The lender may use this figure to determine the refinance loan amount once stabilization is achieved. Need help projecting your stabilized NOI? Schedule a free consultation with our underwriting team.

The difference between trailing NOI and stabilized NOI is critical for value-add investors. Bridge lenders and some permanent loan programs will underwrite to stabilized NOI with appropriate holdbacks to ensure the borrower completes planned improvements.

How Do Lenders Use NOI in Commercial Loan Underwriting?

NOI is the cornerstone of commercial loan underwriting. Lenders use it to calculate three metrics that determine loan approval: DSCR, LTV (through the income approach to value), and debt yield. All three must fall within acceptable ranges.

Debt Service Coverage Ratio (DSCR) equals NOI divided by annual debt service. Most lenders require a minimum of 1.20x to 1.35x depending on the loan program. A 1.25x DSCR means the property generates 25% more income than needed to cover the mortgage. Use our DSCR calculator to test your property's coverage ratio.

Loan-to-Value (LTV) is partly determined by NOI through the income approach. Lenders calculate value by dividing NOI by the market cap rate (Value = NOI / Cap Rate). If NOI is $300,000 and the lender applies a 7.0% cap rate, the indicated value is $4,285,714. At 75% maximum LTV, the loan caps at $3,214,286. Higher NOI directly increases the appraised value and maximum loan amount.

Debt Yield equals NOI divided by the total loan amount, expressed as a percentage. Many CMBS and institutional lenders require a minimum of 8 to 10%. On a $3 million loan with $300,000 NOI, the debt yield is 10.0%. This metric ensures the property generates sufficient income relative to the loan balance, regardless of rate or amortization.

Lenders also stress-test your NOI by applying conservative assumptions. They may increase vacancy to 10%, add management fees if none exist, reduce rental income to market rates, and increase expenses to benchmarks. The resulting lender-underwritten NOI is typically 5 to 15% lower than the borrower's pro forma. Prepare your analysis with this gap in mind.

Contact Clearhouse Lending to discuss how your property's NOI positions you for financing.

How Can You Increase Your Property's NOI?

Increasing NOI is the most direct path to building equity and qualifying for better financing terms. Every additional dollar of NOI increases property value by $12.50 to $20.00 (at cap rates between 5% and 8%), making even modest improvements highly valuable.

Revenue Enhancement Strategies:

Raise rents to market levels. If your units are $100 below market, bringing 20 units to market adds $24,000 in annual rental income and approximately $343,000 in property value at a 7% cap rate. Implement a renovation program to justify premium rents. Adding in-unit washers and dryers, updating kitchens, and installing luxury vinyl plank flooring can support $150 to $300 per month rent premiums.

Add ancillary income sources. Covered parking ($50 to $150/month), storage units ($50 to $100/month), pet rent ($25 to $50/month), and laundry facilities ($30 to $50 per unit/month) all contribute to NOI without increasing operating costs proportionally. Reduce vacancy through better marketing, faster unit turns, and improved tenant retention programs.

Expense Reduction Strategies:

Implement water and energy conservation programs. Low-flow fixtures, LED lighting, and smart thermostats can reduce utility expenses by 15 to 25%. Contest property tax assessments if assessed value exceeds market value. Bid out insurance, landscaping, and maintenance contracts every 2 to 3 years to ensure competitive pricing.

For properties where increased NOI unlocks more borrowing capacity, explore permanent loan programs that reward strong property performance. Ready to discuss your property's potential? Contact our team for a free analysis.

Frequently Asked Questions About NOI Calculation?

What is a good NOI for commercial real estate? A "good" NOI depends on the purchase price and market cap rate. The better question is whether the NOI produces a favorable cap rate return (typically 5 to 10%) and whether the DSCR exceeds lender minimums of 1.20 to 1.35x.

Does NOI include mortgage payments? No. NOI is calculated before debt service. Mortgage principal and interest payments are financing costs, not operating expenses. This allows NOI to be compared across properties regardless of their capital structure.

Should reserves for replacement be included in NOI? Yes. Most lenders include reserves as an operating expense. Typical reserves range from $250 to $500 per unit per year for multifamily. Even if the current owner does not set aside reserves, lenders will deduct them when underwriting.

What is the difference between NOI and EBITDA? NOI applies specifically to real estate and excludes debt service, capital expenditures, depreciation, and income taxes. EBITDA is a broader business metric that may include revenue and expenses beyond the real estate itself. For operating businesses like hotels and self-storage, lenders may analyze EBITDA rather than traditional NOI.

How do you calculate NOI for a vacant property? Calculate a pro forma NOI based on market rents for comparable properties, a market vacancy factor (5 to 10%), and estimated operating expenses using industry benchmarks. Lenders heavily scrutinize pro forma NOI and typically require higher equity or reserves for properties without income history.

What vacancy rate should I use in my NOI calculation? Use the greater of the property's actual vacancy rate or the market average for comparable properties. Most lenders apply a minimum of 5% even for fully occupied properties. Multifamily typically uses 5 to 7%, while office and retail may use 8 to 15%.

Can NOI be negative? Yes. NOI turns negative when operating expenses exceed effective gross income. This occurs with very high vacancy, below-market rents, or excessive operating costs. A negative NOI makes the property ineligible for most conventional financing. Investors acquiring negative-NOI properties typically use cash or bridge financing.

How often should I recalculate NOI? Recalculate monthly using actual income and expense data, and produce a formal trailing 12-month (T-12) statement quarterly. Lenders require current T-12 statements when you apply for refinancing or new financing.

Sources: Appraisal Institute, "The Appraisal of Real Estate" (15th Edition); National Association of Realtors, Commercial Real Estate Income and Expense Analysis; Institute of Real Estate Management (IREM), Income/Expense Analysis Reports; Fannie Mae Multifamily Underwriting Standards; Federal Reserve Bank Commercial Real Estate Lending Guidelines.