Key takeaways
- NOI = effective gross income − operating expenses. Debt service, depreciation, and income taxes stay out.
- Underwrite from the trailing 12 months (T-12), then adjust for what a new owner will actually pay.
- Missing vacancy, management, and reserves are the most common reasons a seller's NOI runs high.
- Lease structure decides which expenses the owner carries. Read the leases before you read the NOI.
The definition
Net operating income is the income a property produces after operating expenses and before debt service and income taxes.
Gross potential rent
− Vacancy and credit loss
+ Expense reimbursements and other income
= Effective gross income (EGI)
− Operating expenses
= Net operating income (NOI)
NOI is the number lenders size loans from and the number cap rates are applied to. If it's wrong, everything downstream is wrong.
What goes in, what stays out
| Usually inside NOI | Usually outside NOI |
|---|---|
| Base rent and percentage rent | Mortgage principal and interest |
| Tenant reimbursements (taxes, insurance, CAM) | Depreciation and amortization |
| Other income: parking, signage, storage | Owner's income taxes |
| Vacancy and credit loss | Capital improvements (often handled as reserves or below the line) |
| Property taxes and insurance | Tenant improvements and leasing commissions (often below the line) |
| Repairs, maintenance, utilities the owner pays | Owner's personal or entity expenses |
| Management fee, even if self-managed | One-time items such as a lawsuit settlement |
Reserves, tenant improvements, and leasing commissions are where practice varies. Some analysts deduct reserves above the NOI line, some below. Be consistent, and know which convention the seller used before you compare cap rates.
Trailing 12 months, pro forma, and underwritten NOI
- Trailing 12 months (T-12): what the property actually collected and spent over the last year. The starting point.
- Pro forma: what someone projects the property could produce. Useful for spotting upside. Not a basis for price.
- Underwritten: the T-12 adjusted for what a new owner will face: reassessed property taxes, a real management fee, reserves, current insurance quotes, and known lease changes.
I start from trailing actuals and label every input as verified or inferred, so a client can see which numbers are documented and which are estimates.
Lease structure changes the math
Under a triple-net (NNN) lease, the tenant reimburses taxes, insurance, and common area maintenance, so those expenses largely wash out of NOI. Under a gross lease, the owner pays them from the rent. Two buildings with the same rent can have very different NOIs. See NNN, modified gross, and full service leases.
Also check whether reimbursements were actually billed and collected. A lease that allows a pass-through doesn't mean the owner collected it.
A quick example
| Amount | |
|---|---|
| Gross potential rent (3 tenants) | $96,000 |
| Vacancy and credit loss (7%) | ($6,720) |
| CAM reimbursements collected | $14,400 |
| Effective gross income | $103,680 |
| Property taxes | ($13,200) |
| Insurance | ($9,800) |
| CAM and repairs | ($15,600) |
| Management (5% of EGI) | ($5,184) |
| Reserves | ($3,000) |
| Net operating income | $56,896 |
Illustrative example. Hypothetical numbers chosen to show the math. Your property's numbers will differ.
Common questions
Is NOI calculated before or after the mortgage?
Before. NOI excludes debt service. Subtract annual debt service from NOI to get cash flow before taxes.
Does NOI include capital expenditures?
Usually not directly. Many analysts deduct a reserve for replacements above NOI, and others treat capital spending below NOI. Use one convention consistently when comparing properties.
What's the difference between NOI and cash flow?
Cash flow is what's left after debt service and capital spending. NOI is the property's operating result before financing.
Why start with trailing numbers?
Trailing numbers are documented. Projections are assumptions. Start with the trailing 12 months and adjust for known changes, such as a property tax reassessment after the sale.
General information, not legal, tax, accounting, or investment advice. Examples marked illustrative use hypothetical numbers.