CRE 101 Series

1. 1. What is CRE?
2. 2. The T12
3. 3. NOI Explained
4. 4. Cap Rates
5. 5. Property Types
6. 6. How Properties Make Money
7. 7. Lease Structures
8. 8. Financing Fundamentals
9. 9. Key Investment Metrics
10. 10. Valuation Basics
11. 11. Reading a Rent Roll
12. 12. Pro Forma Rent
13. 13. Risk Profiles
14. 14. Due Diligence
15. 15. The Acquisition Process

In This Article

What Is Net Operating Income (NOI)? A Beginner's Guide

Net Operating Income, or NOI, is the single most important number in commercial real estate. Nearly every other metric you'll use to evaluate a deal, cap rate, DSCR, valuation, all of it starts with NOI. If you don't have a clear handle on what it is and what it excludes, everything downstream gets shaky.

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What NOI Actually Is

NOI is the income a property generates from operations, after operating expenses, but before financing costs and capital costs. It's meant to represent how the property performs on its own, independent of how it's financed or who owns it.

Effective Gross Income is the total income the property collects from rent and ancillary income, after subtracting loss-to-lease, vacancy, bad debt & concessions. Operating Expenses are the costs of running the property day to day.

What's Included vs. What's Excluded

This is where most beginners get tripped up, so let's be explicit.

Included in NOI:

• Rental income
• Other income (parking, laundry, pet fees, storage, etc.)
• Property taxes
• Insurance
• Utilities
• Repairs and maintenance
• Property management fees
• Payroll for onsite staff

Excluded from NOI:

• Debt service (mortgage principal and interest)
• Capital expenditures (roof replacement, major renovations, etc.)
• Depreciation
• Income taxes

The reason NOI excludes debt service and capex is deliberate. NOI is supposed to measure the property itself, not the financing structure or ownership decisions layered on top of it. Two investors could buy the same building, one with an all cash purchase and one with a loan, and the NOI would be identical for both. Only the cash flow after those costs would differ.

Vacancy and Credit Loss

Vacancy and credit loss is the gap between what a property could theoretically collect and what it actually collects. It covers two things: units sitting empty (vacancy) and tenants who don't pay what they owe (credit loss).

Underwriters typically apply a vacancy and credit loss assumption as a percentage of gross potential income, based on the property's historical performance and the local market. A stabilized multifamily property might run 5 to 7 percent, while a property in lease up or a rougher submarket could run higher. This assumption has a real impact on the resulting NOI, so it shouldn't be an afterthought or a copy paste from another deal.

Capital Expenditures: Above the Line or Below the Line?

This is one of the most common points of confusion for people newer to underwriting, so let's state it plainly: capital expenditures sit below the line, meaning they are not included in the NOI calculation.

"Above the line" refers to anything counted before you arrive at NOI, meaning operating income and operating expenses. "Below the line" refers to everything that comes after NOI is calculated, including debt service and capital expenditures.

A new roof, a full unit renovation, or a major mechanical replacement are all capital costs. They improve or extend the life of the asset rather than maintain its day to day operation, so they don't belong in the NOI calculation. This matters because if capex gets miscategorized as an operating expense, it artificially lowers NOI, which in turn understates the property's value.

Worked Example

Take a 100-unit multifamily property. Gross Potential Income is $1,200,000. Vacancy and Credit Loss at 6% is ($72,000), bringing Effective Gross Income to $1,128,000. Operating Expenses are ($478,000). That leaves an NOI of $650,000.

This is the same $650,000 NOI figure used throughout the site's glossary examples, so the numbers stay consistent as you move between articles and tools.

Why NOI Matters

NOI is the foundation for nearly everything that comes next in underwriting a deal:

• Cap Rate is NOI divided by purchase price
• DSCR compares NOI to the annual debt payment
• Valuation under the income approach capitalizes NOI into a property value

Get NOI wrong, even by a small margin, and every number built on top of it is wrong too.

Common Mistakes

• Confusing NOI with cash flow. Cash flow accounts for debt service and capital costs. NOI does not.
• Burying capex inside operating expenses. A large one time repair or renovation cost should be pulled out and treated as capital, not operating.
• Using an unrealistic vacancy assumption. Copying a vacancy factor from a different deal or market without checking it against the subject property's actual history is a common shortcut that leads to an inflated NOI.
• Forgetting one time or non-recurring items. A one time insurance settlement or a legal payout shouldn't be baked into a stabilized NOI number, since it won't repeat going forward.

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