Net Operating Income (NOI)

Net operating income (NOI) is a property's yearly income after operating costs, but before loan payments and income taxes. It shows how much cash the property itself produces, no matter how it's financed or who owns it.

The formula in words: NOI equals total property income, minus vacancy and collection losses, minus operating expenses.

• Income includes rent and other property income, such as parking or laundry fees.
• Vacancy and collection loss covers empty units and unpaid rent.
• Operating expenses include property taxes, insurance, utilities, repairs, management fees and a reserve for replacing big items like roofs and heating systems.

NOI does not subtract loan principal or interest, depreciation or income taxes. US bank examiners define it the same way. They add that a replacement reserve should be counted for underwriting even if the owner doesn't actually set the money aside.

Worked example. A 10-unit building could earn $200,000 a year in rent if fully leased. The lender assumes 5% vacancy, or $10,000, which leaves $190,000. Operating expenses, including a replacement reserve, total $80,000. NOI = $190,000 − $80,000 = $110,000.

Why it matters for lenders

NOI is the starting point for nearly every income-property test. It feeds the debt service coverage ratio (DSCR), debt yield, and the capitalization rate (cap rate) used to estimate value. If NOI is overstated, every one of those numbers looks better than it should.

Borrowers' NOI figures often run high. A seller's statement may leave out a management fee because the owner manages the building, skip the replacement reserve, or count rents that haven't been signed yet. So lenders rebuild NOI with their own assumptions. The result is often called underwritten NOI.

How it works in practice

A lender reviews a DSCR loan on a small apartment building. The broker's package shows NOI of $130,000. The underwriter rebuilds it from the rent roll and the last two years of operating statements.

She makes three changes. She adds a market-rate management fee, even though the owner manages the building himself. She raises the vacancy rate to match the local market. And she adds a replacement reserve for each unit. Underwritten NOI comes in at $112,000. That lower figure drives coverage, debt yield and value, and it supports a smaller loan than the borrower asked for.

The lender saves both versions, the borrower's and its own, with each change and the reason for it. Next year, when new statements arrive, the analyst compares actual NOI to the underwritten figure line by line. In a spreadsheet, last year's adjustments are often lost, and the analysis starts over from scratch.