What net operating income is
Net operating income is what a property earns in a year after paying to run it, but before any loan payments, depreciation or income taxes. Almost every other number in commercial real estate is built on it. Appraisers divide it by a cap rate to get value. Lenders divide it by the annual mortgage payment to get the debt service coverage ratio. Buyers compare it with the price to decide what to offer.
Because NOI ignores financing, two identical buildings have the same NOI whether one is owned free and clear and the other carries a large loan. That is what makes it useful for comparing properties and for sizing a new loan.
What goes in, and what stays out
Income: rent from every unit or suite at current lease rates, as if the building were full, plus other income such as parking, laundry, storage, signage, and expense reimbursements from tenants on net leases. Then subtract vacancy and credit loss. Most lenders apply at least 5% even when the building is 100% leased, and more in soft markets.
Operating expenses: property taxes, insurance, owner-paid utilities, repairs and maintenance, contract services, management, replacement reserves, and administrative costs such as legal, accounting and licenses.
Not operating expenses:
- Mortgage principal and interest (that is debt service, and it is what NOI gets compared against)
- Depreciation and amortization
- Income taxes
- Capital improvements such as a new roof or parking lot (reserves cover these on an annual basis instead)
- Tenant improvements and leasing commissions, which lenders often handle as a separate reserve
Worked example
A small apartment or mixed-use building with $480,000 of scheduled rent and $12,000 of other income, using the calculator’s default numbers:
- Gross potential income: $492,000
- Less 5% vacancy on rent: $24,000, leaving effective gross income of $468,000
- Operating expenses, including 4% management and $9,000 of reserves: $150,720
- Net operating income: $317,280 a year, an expense ratio of 32.2%
At a 7% cap rate that income points to a value of about $4,532,571. With a loan at 7.25% on a 25-year amortization, a lender capped at 75% LTV and 1.25x DSCR would lend about $2,926,370, limited by the income test. If the current loan balance were $2,000,000, a refinance on these numbers could release roughly $926,370 before closing costs. The cash-out refinance calculator takes the costs and payoff into account.
Your NOI vs. the lender’s NOI
Owners and sellers usually report a higher NOI than the one a lender will underwrite. The gap almost always comes from three lines:
- Vacancy. A full building still gets a vacancy factor.
- Management. If you manage it yourself, the lender still deducts a market fee, usually 3–5% of income, because a future owner (or the lender, after a foreclosure) would have to pay one.
- Reserves. Lenders set aside money every year for roofs, HVAC and paving, even though nothing is spent in most years.
In the example, leaving out those three items would show NOI of $369,000, $51,720 more than the underwritten figure. At a 7% cap rate that is about $738,857 of value that won’t show up in the appraisal. Run your numbers the lender’s way before you apply, so the loan amount isn’t a surprise. Lenders also tend to use the trailing 12 months of actual income and expenses, and may reassess property taxes if you are buying.
Expense ratios by property type
The expense ratio is operating expenses divided by effective gross income. It is a quick check on whether an operating statement is realistic:
| Property type | Typical expense ratio |
|---|---|
| Multifamily (owner pays some utilities) | 35–50% |
| Office (gross or modified gross leases) | 35–50% |
| Retail and industrial on triple-net leases | 5–20% (tenants reimburse most costs) |
| Self storage | 30–40% |
| Hotels and motels | 65–75% of total revenue |
These are broad ranges, not underwriting rules. Older buildings, high-tax states and properties where the owner pays all utilities run higher. If a listing shows a ratio well below these ranges, look for missing expenses before trusting the cap rate.
Raising NOI before a refinance
Every dollar of NOI is worth many dollars of value. At a 7% cap rate, $10,000 more NOI a year adds about $142,857 to the appraisal. In the example, a 5% rent increase lifts NOI to $339,168. The usual levers before an appraisal:
- Bring below-market leases up to market at renewal, and sign new leases on vacant space.
- Bill back taxes, insurance and common-area costs where leases allow it.
- Add or raise other income: parking, storage, laundry, utility billing.
- Rebid insurance and service contracts, and appeal the tax assessment if it is out of line.
Lenders want to see higher income in place, ideally for a few months, not just projected. Once it is, the cap rate calculator shows the value and the loan amount calculator shows which lender test limits you.