In commercial real estate, few numbers carry more weight than net operating income, or NOI. Whether you’re financing an acquisition, seeking a refinance, or trying to determine a property’s value, NOI is one of the first figures lenders and investors look at.
But how exactly does it influence loan terms and valuation? Let’s break it down.
What Is NOI?
NOI, or net operating income, is the income a property generates after all operating expenses are deducted, but before any debt service or capital expenditures.
Here’s the basic formula:
NOI = Gross Income – Operating Expenses
Think rent, parking fees, and reimbursements, minus things like property management, insurance, taxes, and maintenance. It’s a clean snapshot of how much cash the property produces before any financing is involved.
How Lenders Use NOI
Lenders rely heavily on NOI because it shows whether a property can support its own debt. If the NOI is too low, the property may not be able to cover its loan payments, even if the borrower has a strong profile.
Here’s how NOI directly affects underwriting:
Debt Service Coverage Ratio (DSCR)
Most lenders require a minimum DSCR, typically around 1.25x. That means your NOI must be at least 25% greater than the annual loan payments.
Example:
If your property generates $625,000 in NOI and the DSCR requirement is 1.25x, the max annual debt service allowed is $500,000. That figure will determine your maximum loan amount.
Debt Yield
Debt yield is another ratio used to assess risk. It’s calculated by dividing NOI by the loan amount.
Debt Yield = NOI ÷ Loan Amount
Lenders often set a minimum debt yield, such as 8% or 9%, as a floor for loan sizing. A higher NOI can help you qualify for more leverage under both debt yield and DSCR tests.
How NOI Impacts Valuation
Valuation in CRE is often based on the income approach, where value is a function of NOI and cap rate:
Value = NOI ÷ Cap Rate
This means a small change in NOI can create a significant swing in value, especially in low cap rate environments.
Example:
At a 6% cap rate, a $50,000 increase in NOI boosts value by over $800,000. That can dramatically affect sale price, refinance proceeds, and investor equity.
Why NOI Quality Matters
Not all income is viewed equally. Lenders and appraisers will scrutinize the quality and stability of your NOI. For example:
Is the rent roll diversified or heavily reliant on one tenant?
Are rents at or above market?
Are there upcoming lease expirations?
Are operating expenses reasonable and recurring?
If the income appears inflated, temporary, or inconsistent, lenders may apply discounts or normalize the NOI downward during underwriting.
Final Thoughts
NOI is more than just a number. It is the backbone of commercial real estate finance. It influences loan size, interest rate, and valuation, and it is one of the first things lenders analyze when reviewing a deal.
Whether you’re preparing for an acquisition, a refinance, or a future sale, knowing how your NOI stacks up can give you a real edge in negotiations and planning.
If you’re evaluating a property and want help understanding how your NOI affects financing potential, we’re happy to take a look.
