Net operating income is a property's total revenue minus vacancy and credit loss minus all operating expenses, calculated before any debt service payments, income taxes, depreciation, and capital expenditures. That 'before debt' boundary is not incidental; it is the metric's defining feature.
Because NOI sits above the financing line, it is a property-level measure of economic productivity that is the same whether the building is owned free and clear or encumbered with a mortgage. This makes NOI the universal CRE performance metric: lenders, appraisers, asset managers, and equity underwriters all begin with NOI before applying their own discipline's lens.
The income side of the NOI calculation starts with gross potential revenue (rent at 100% occupancy plus other income such as parking, antenna fees, and laundry revenue) and then deducts a vacancy and credit loss allowance to arrive at effective gross income. From EGI, the operating expense deductions follow: property taxes, insurance, property management fees, routine maintenance and repairs, utilities paid by the landlord, and janitorial and landscaping.
What does not appear above the NOI line is equally important: mortgage principal and interest, tenant improvement allowances, leasing commissions, and capital expenditures such as roof replacements and major mechanical upgrades are all excluded. Whether to include a reserves-for-replacement line is debated among practitioners; institutional appraisers frequently deduct a replacement reserve, while lenders often underwrite without one and instead stress the DSCR using a capital expenditure overlay.
NOI drives three distinct workflows across the industry. In valuation, the income capitalization approach produces value as NOI divided by the market cap rate; a $1.2 million NOI capitalized at 5.5% implies a $21.8 million property value.
In lending, debt service coverage ratio equals NOI divided by annual debt service; most institutional lenders require a minimum 1.20x-1.25x DSCR at underwriting. In asset management, NOI per square foot, NOI margin (NOI as a percentage of EGI), and NOI growth relative to budget are the primary performance attribution metrics tracked quarterly against the business plan and against NCREIF benchmarks for the asset class.
Pro-forma NOI routinely overstates likely actual NOI, and identifying the gap is one of the most consequential skills in acquisition underwriting. Common manipulation points include applying a market management fee to an owner-managed property (which can swing NOI by 2-4% of EGI), assuming aggressive stabilized vacancy when in-place vacancy is elevated, normalizing away non-recurring expenses that recur in practice, and excluding reserves for replacement to inflate apparent NOI.
Below-market contract rents on long-term leases will also make stabilized market-rate NOI look higher than the in-place NOI the buyer inherits on day one. A disciplined underwriter runs both an in-place NOI (reflecting actual leases) and a stabilized NOI (reflecting market assumptions) and demands that the seller's stated NOI be reconciled to actual trailing operating statements before the price is agreed.