What NOI Includes and What It Leaves Out

Net operating income is the workhorse metric of commercial real estate. Value depends on it. Loan sizing depends on it. Cash flow projections depend on it. But NOI is also one of the most inconsistently calculated numbers in the business. A Rochester commercial property’s advertised NOI often differs from the NOI a careful buyer or lender would use by 10 to 25 percent in the seller’s favor. Knowing what NOI does and does not include prevents overpaying based on inflated numbers.

What NOI includes. Gross rental income from tenants under current lease terms. Reimbursements from tenants for taxes, insurance, and CAM under NNN leases. Parking income if the property has metered or reserved parking. Storage income for buildings with rentable storage. Vending income and signage or antenna lease income where applicable. Late fees and other recurring ancillary income. All these show up on the income side above the operating expense line.

What NOI removes on the expense side. Property taxes based on the actual assessed value the current owner pays. Property insurance premiums. Utilities the landlord covers. Common area maintenance including landscaping, snow removal which matters significantly in Michigan winters, parking lot upkeep, and shared area repairs. Property management fees typically at 3 to 5 percent of gross income. Reserves for capital replacements. Legal and accounting fees. Marketing expenses for leasing vacancy. Bad debt from tenants who fail to pay.

What NOI leaves out. Debt service is not an operating expense and does not reduce NOI. Two identical Rochester warehouses with different loans still have the same NOI. Debt service affects cash flow after NOI but not NOI itself. Depreciation is a tax deduction, not a cash expense, and does not reduce NOI. Capital expenditures for major replacements like roofs and HVAC units get reserved against in NOI rather than expensed dollar for dollar in the year they occur. Income taxes paid at the owner or entity level are not property expenses and stay out of NOI.

The categories that get manipulated in advertised NOI. Property management fees are often set to zero when the seller self manages, understating the cost a buyer would face after hiring a manager. Capital reserves get skipped even though the property clearly needs them. Utilities are estimated at prior year levels even when rates have risen. Property taxes are stated at the seller’s current bill rather than the buyer’s likely post sale bill after Michigan’s property tax uncapping. Vacancy allowances get excluded on fully occupied properties even though realistic underwriting expects some vacancy.

The rebuilt NOI a careful buyer uses. Verified rents from leases and estoppels. Full operating expenses including property management at 3 to 5 percent of gross. Capital reserves at $0.25 to $1 per square foot annually depending on building age. Post sale property tax estimates that account for Michigan uncapping. Vacancy at 5 to 10 percent depending on property type and submarket. Realistic utility numbers. Bad debt at 1 to 3 percent. The rebuilt NOI almost always sits below the marketing NOI, and the gap represents the adjustment a lender or serious investor will make.

Why the gap matters. At a 7 percent cap rate, every $10,000 of NOI adjustment moves property value by $143,000. A $30,000 NOI adjustment shifts value by $429,000. Buyers who accept marketing NOI overpay by these amounts consistently. Sellers who present inflated NOI attract attention early but lose deals later when buyer diligence surfaces the gap. Michigan winters make the snow removal line item worth particular attention because it varies year to year and can be understated in a mild winter following heavy ones.

TDG Commercial, known as best commercial real estate agents in Rochester, rebuilds NOI on every deal it works, both to protect buyers from overpaying and to help sellers present credible numbers that survive diligence.