What Is NOI in Commercial Real Estate?

You built a tight underwriting model. The debt yield clears. The DSCR clears. You submit the loan package expecting to close at the number you modeled.

The term sheet arrives at $1.2 million less than requested. Nothing in the capital structure changed. The only variable that moved was NOI — and the lender's version of it is not the same as yours.

NOI is the single most important number in commercial real estate finance. Every formula a lender uses to size your loan starts with it. Understanding exactly what it is, how it is calculated, and how lenders adjust it before applying it to any formula is the difference between modeling accurately and getting blindsided at term sheet.

The NOI formula

Net operating income is a property's total income minus vacancy losses and operating expenses, before any debt service.

NOI = Gross Potential Income
    − Vacancy and Credit Loss
    − Operating Expenses

It deliberately excludes mortgage payments. The point is to measure the property's income independent of how it is financed — the same property in the same market should produce the same NOI whether it carries $5M or $15M of debt. That neutrality is why every lender uses it as the foundation.

What counts as operating income

Gross potential income includes:

• Base rent — contractual scheduled rent from all tenants, at full occupancy
• Expense reimbursements — NNN tenants who pay their share of taxes, insurance, and CAM
• Parking income — structured or surface lot revenue
• Laundry and storage — on multifamily properties
• Signage and antenna income — rooftop or facade lease revenue
• Miscellaneous fees — late fees, pet fees, amenity fees on multifamily

What does not count: interest income, loan proceeds, capital contributions, or any income that is not tied to the property's ongoing operations.

What counts as operating expenses

Operating expenses are recurring costs to keep the property running:

• Property taxes
• Insurance premiums
• Property management fees (typically 3%–5% of EGI)
• Repairs and maintenance
• Utilities paid by the landlord
• Landscaping, snow removal, security
• Accounting and legal fees specific to the property

What does not count: mortgage payments, capital expenditures (a new roof, a parking lot replacement), depreciation, or income taxes. Those are handled separately.

The replacement reserve: where borrowers most often go wrong

Most borrowers calculate NOI and stop before adding replacement reserves. Lenders add them back.

A replacement reserve is an annual allowance for capital expenditure items — roofs, HVAC systems, parking surfaces, elevators — that are not annual maintenance costs but are inevitable over the hold period. Lenders typically underwrite $0.15–$0.35 per square foot depending on property age and type.

If you have a 75,000 square foot building and the lender applies a $0.25/sqft reserve:

Reserve deduction: 75,000 × $0.25 = $18,750 per year

That $18,750 reduction flows directly into the NOI the lender uses. At a 9% debt yield floor, every $18,750 of NOI reduction costs you $208,333 of maximum loan proceeds.

Vacancy: the number borrowers underestimate most

Borrowers typically use their current actual vacancy — often 0%–3% because the building happens to be full. Lenders apply a market vacancy factor regardless of current occupancy. Fannie Mae's DUS underwriting guidelines require lenders to apply economic vacancy rates derived from market data, not from the current rent roll. Freddie Mac's multifamily standards follow the same principle.

For a stabilized multifamily in a strong market, lenders might apply 5%. For office with any lease rollover, 10%–15% or more. For retail with a major tenant on a short remaining term, lenders have been known to stress-test that tenant's entire revenue as if the space goes dark.

On a $2,000,000 gross rent roll at 5% lender vacancy vs. 2% borrower vacancy:

At a 10% debt yield floor, that $78,750 gap in NOI translates to $787,500 less in maximum loan proceeds — before the lender has made a single other adjustment.

How lenders further stress NOI on riskier assets

On assets with near-term lease expirations, lenders do not stop at market vacancy. They run a stress-test scenario.

If a retail center has an anchor tenant whose lease expires in 18 months, the lender may assume that space goes dark for six months, calculate the lost rent, add estimated tenant improvement and leasing commission costs to re-tenant, and deduct that entire amount from NOI before applying any formula. A property reporting $1,100,000 of current NOI might be underwritten at $968,000 after the stress-test — and every formula runs on $968,000.

This explains why the same CMBS term sheet that quotes a 10% floor might produce a loan amount that implies an 11.5% debt yield on your submitted NOI. The lender did not raise the floor; they lowered the NOI.

Why NOI is not the same as cash flow

NOI measures property-level income before financing. It is not what the borrower takes home. The path from NOI to cash flow includes:

NOI
− Annual Debt Service (principal + interest)
= Before-Tax Cash Flow

Before-Tax Cash Flow
− Income Taxes
= After-Tax Cash Flow

Lenders care about NOI because it measures the property independently of the financing structure. Borrowers care about cash flow because it measures what they actually receive after the mortgage payment.

NOI in the three lender formulas

All three begin with the same number. A lower underwritten NOI simultaneously reduces the maximum loan by debt yield, the coverage ratio by DSCR, and the implied value by cap rate. That is why the NOI discrepancy between borrower and lender propagates across every metric on the term sheet at once.

Use the debt yield calculator and the CRE loan sizing calculator to model what different NOI assumptions do to your maximum proceeds across all three constraints simultaneously.

Frequently asked questions

What is the difference between NOI and EBITDA? EBITDA (earnings before interest, taxes, depreciation, and amortization) is a corporate finance metric that includes all revenue streams across a business. NOI is a real estate metric that focuses specifically on a property's rental income and direct operating expenses. For a single-tenant NNN property, they may be similar. For a complex operating business like a hotel, they diverge significantly — which is why hotels require a different underwriting approach than traditional income properties.

Can a property have negative NOI? Yes. If operating expenses exceed gross income — possible on a newly acquired vacant building or a severely over-improved asset — NOI is negative. No lender will size a loan against negative NOI. The loan is either sized on a future stabilized NOI basis (with strict conditions on the draw structure) or the deal does not finance at all until income improves.

Should I include capital expenditures in NOI? No. Capital expenditures — roof replacement, HVAC overhaul, major systems — are not operating expenses and are not deducted in the NOI calculation. However, lenders add a replacement reserve line item that estimates the annual cost of future capital expenditures on a recurring basis. That reserve is included in the lender's NOI deduction even though it is not a current-year cash expense.

How does NOI differ on a multifamily property vs. an office building? The income composition differs. Multifamily NOI is built primarily from rent, pet fees, parking, and laundry. Office NOI includes base rent plus tenant expense reimbursements that vary by lease structure. The operating expense ratio also differs — multifamily operating expenses typically run 35%–50% of EGI, while office can run higher due to common-area maintenance, tenant improvement obligations, and leasing costs. Lenders apply different reserve and vacancy assumptions by property type for the same reason.

What is effective gross income (EGI) and how does it relate to NOI? EGI is gross potential income minus vacancy and credit loss. It is the income the property is expected to actually collect. NOI is EGI minus operating expenses (and, in lender underwriting, minus replacement reserves). EGI is the intermediate step between gross income and NOI.