Reviewed by Robert Mendieta Jr., CCIM — Associate Broker · Commercial Division · DRE #01422904
Apex Real Estate Services · Last updated: October 4, 2026
Knowing how to calculate net operating income is the first skill in commercial underwriting, because value, loan size and debt coverage all start from it. The Office of the Comptroller of the Currency (OCC) says collateral value “is largely determined by a property’s NOI.” This NOI real estate guide uses a hypothetical industrial building, where tenant reimbursements do much of the work.
The direct answerWhat Is Net Operating Income (NOI) in Commercial Real Estate?
Net operating income (NOI) is a commercial property’s annual income — rent, tenant expense reimbursements and other income such as parking — minus an allowance for vacancy and credit loss and minus the costs of operating and maintaining the property. It is measured before debt service, income taxes, depreciation and actual capital spending.
That matches our glossary entry for NOI (net operating income). One nuance matters to lenders: the OCC says operating expenses exclude capital items yet “do include a reserve for replacing capital items,” whether or not it is funded.
A quick test for any NOI commercial real estate figure you are handed: is it annual, does it include a vacancy allowance, and is debt service kept out?
Key Takeaways
- NOI = effective gross income − operating expenses, and effective gross income = potential gross income − vacancy and credit loss.
- Debt service, income taxes, depreciation and actual capital spending stay out; lenders still deduct a replacement reserve.
- Under NNN leases, count reimbursements as income only if the reimbursed costs are also in expenses.
- Lenders size loans from NOI: DSCR = NOI ÷ annual debt service; debt yield = NOI ÷ loan amount.
- In the Inland Empire, build NOI from collected rent: CoStar reports the industrial triple-net asking average for available space about 25% below its 2023 peak, with free rent common on larger new leases (Q3 2026).
What Is the Net Operating Income Formula?
The net operating income formula is two subtractions: vacancy and credit loss come off potential gross income, then operating expenses come off effective gross income.
The net operating income formula
Potential gross income (PGI) − Vacancy & credit loss = Effective gross income (EGI)
Effective gross income − Operating expenses = Net operating income (NOI)
- Potential gross income. Annual income at full occupancy, per California’s Board of Equalization (BOE), plus reimbursements and other income such as parking.
- Vacancy and credit loss. An allowance for vacancies, turnover and unpaid rent.
- Effective gross income. What remains after that allowance.
- Operating expenses. Costs “necessary to maintain the real property and continue the production of gross income.”
How to Calculate Net Operating Income, Step by Step
Annualize the rent, add reimbursements and other income, subtract vacancy and credit loss, then subtract every operating expense. Here is how to calculate NOI on a hypothetical 30,000-square-foot, three-unit industrial building leased NNN.
- Annualize the rent. Multiply monthly rent by 12.
- Add reimbursements and other income. NNN recoveries of taxes, insurance and CAM, plus trailer-parking income.
- Subtract vacancy and credit loss. The result is effective gross income.
- Subtract operating expenses. Include management and a replacement reserve.
- What remains is NOI.
| Line | Calculation | Amount |
|---|---|---|
| Potential base rent | 30,000 SF × $1.00/SF/mo × 12 | $360,000 |
| + Expense reimbursements | NNN recoveries of taxes, insurance, CAM | $84,000 |
| + Other income | Trailer-parking stalls | $6,000 |
| = Potential gross income | 360,000 + 84,000 + 6,000 | $450,000 |
| − Vacancy & credit loss | 5% × $450,000 | ($22,500) |
| = Effective gross income | 450,000 − 22,500 | $427,500 |
| − Property taxes | Assumed | ($48,000) |
| − Insurance | Assumed | ($18,000) |
| − CAM / repairs & maintenance | Assumed | ($18,000) |
| − Management | 3% × $427,500 (assumption) | ($12,825) |
| − Replacement reserve | $0.15/SF/yr × 30,000 SF | ($4,500) |
| = Total operating expenses | 48,000 + 18,000 + 18,000 + 12,825 + 4,500 | ($101,325) |
| = Net operating income | 427,500 − 101,325 | $326,175 |
The operating expense ratio — operating expenses divided by effective gross income — is 101,325 ÷ 427,500 = 23.7% here. The 3% management fee is an assumption; the OCC’s office-property discussion cites fees “typically underwritten from 3 percent to 5 percent of effective gross income,” a lender convention rather than an industrial market fact.
Lenders deduct the $4,500 reserve even though no check is written.
Above and below the lineWhat Counts as an Operating Expense — and What Stays Out of NOI?
Operating expenses are the recurring costs of running and maintaining the property; financing, income taxes, depreciation and actual capital spending stay out.
| Line item | In NOI? | Why |
|---|---|---|
| Property taxes | Yes | Fixed expense |
| Property insurance | Yes | Fixed expense |
| CAM, repairs, maintenance, janitorial | Yes | Variable expenses |
| Utilities (owner-paid) | Yes | Variable expense |
| Property management | Yes | Underwritten even if self-managed |
| Replacement reserve | Yes (lender NOI) | Imputed whether or not funded |
| Mortgage interest and principal | No | Financing, not operations |
| Income taxes | No | Owner-level, not property-level |
| Depreciation | No | Tax deduction, not an outlay |
| Actual capital expenditures | No (below the line) | The reserve stands in for them |
| Tenant improvements and leasing commissions | Varies | “Not always considered as an operating expense”; confirm with your lender |
NOI is calculated before the actual roof check, but lenders smooth that lumpy spending into an annual reserve so a building needing a roof next year does not look rich this year.
Depreciation is the other trap: the IRS gives nonresidential real property a 39-year recovery period under its general depreciation system (GDS), but that tax deduction never touches NOI.
Assessors valuing property for property-tax purposes handle property taxes in the capitalization rate instead, per the BOE. For investors and lenders, property taxes are an operating expense.
Lease structureHow Do NNN and Gross Leases Change NOI?
Lease structure decides who pays operating costs, and so how much of them NOI absorbs. Under a triple net (NNN) lease, the tenant pays or reimburses taxes, insurance and maintenance. CoStar notes this makes “the net income stream more predictable.”
The OCC says reimbursements may be included in income “if the reimbursed expenses are included in the operating expenses.” The BOE leaves both out. Either works; counting one side without the other breaks NOI.
Vacancy is where NNN owners feel it. In the hypothetical, reimbursements cover all $84,000 of recoverable costs only at full occupancy, so the 5% vacancy allowance leaves 5% × $84,000 = $4,200 with the owner.
Under a gross lease with the same $1.00 rent and no reimbursements, the owner still pays that $84,000, so NOI falls unless base rent is higher. Our guide to gross lease vs net lease covers that trade-off; CAM charges explains the shared-area line. Reconciling that line against the year-end statement is its own check; see our CAM reconciliation guide.
Read the lease, not the label. The OCC warns that lease-type terms “lack universally agreed-upon definitions,” so analyze the lease itself. See our overview of types of commercial leases.
NOI vs Cash Flow: Why Aren’t They the Same Number?
NOI measures what the property earns from operations; cash flow is what the owner keeps after the mortgage and capital and leasing costs. Unlike cash-flow analysis, the OCC notes, NOI may use market vacancy and deduct non-cash items such as reserves.
| Metric | Formula | What it tells you | Hypothetical example |
|---|---|---|---|
| NOI | EGI − operating expenses | The property’s earning power before financing | $326,175 |
| Debt service coverage ratio (DSCR) | NOI ÷ annual debt service | The borrower’s ability to service the debt | $326,175 ÷ $220,000 = 1.48× |
| Debt yield | NOI ÷ loan amount | NOI as a percent of the loan | $326,175 ÷ $3,500,000 = 9.3% |
| Cash flow before tax | NOI − debt service − capital and leasing costs paid | Cash to the owner before income tax | $326,175 − $220,000 − $40,000 = $66,175 |
Treated below the line, as in this example, one $40,000 re-lease leaves NOI untouched but takes a large bite out of cash, which is why the OCC calls re-leasing costs “an important consideration when analyzing cash flow.”
NOI also drives value: direct capitalization divides NOI by a cap rate, so at a hypothetical 6.0% cap this NOI implies $5,436,250. The full method is in our guide on how to calculate cap rate. For current Inland Empire cap rate levels, see our guide to Inland Empire industrial cap rates.
Which NOI?In-Place, Stabilized or Pro Forma: Which NOI Are You Looking At?
Always ask which NOI you are looking at: in-place reflects today’s leases, stabilized normalizes vacancy and expenses, and pro forma is a projection.
- In-place NOI uses contract rent. Check it against the trailing operating statement and rent roll. Buyers can track both on our commercial real estate due diligence checklist.
- Stabilized NOI starts fully leased, then applies a vacancy factor that “may be higher or lower than actual.”
- Pro forma NOI projects future leasing and income.
Be careful with tax returns: the OCC notes a return for a year when real estate taxes went unpaid would “understate expenses and overstate income.”
Local market · CoStar, Q3 2026What’s Moving NOI in the Inland Empire Right Now?
In the Inland Empire, asking and collected rents have separated, so the income line needs extra scrutiny. Figures are market-wide.
CoStar · Inland Empire Industrial Market Report · Q3 2026
- Vacancy 8.7%; availability 12.5%, a 15-year high.
- Market asking rent growth −0.9% year over year; free rent is common on new, larger leases of 5 years or longer.
- The triple-net asking average for available space remains about 25% below its 2023 peak; with concessions, CoStar reports effective rents up to 40% lower, depending on location, size and vintage.
Build income from rent collected after concessions; capitalizing asking rent overstates NOI.
The gap also runs the other way. Market asking rents are still up about 20% from five years ago and have nearly doubled over the past decade, per CoStar, so long-held leases roll up at expiration. Investors have “traded upfront yields for total return as they await opportunities to mark in-place rents to market.” Underwrite both in-place and stabilized NOI.
Retail is steadier: CoStar puts Inland Empire retail vacancy at 6.0% and asking rent growth at 3.1% year over year. See our Inland Empire industrial market page and the quarterly Inland Empire market reports.
California property taxHow Does a California Sale Reset the Property-Tax Line in NOI?
In California, a purchase triggers reassessment, so a buyer’s NOI should reprice the property-tax line instead of inheriting the seller’s bill. Article XIII A of the California Constitution resets full cash value to the appraised value at purchase, caps the tax at 1% of that value (voter-approved levies fall outside the cap) and limits inflation increases to 2% a year.
In the hypothetical, a buyer paying $5,436,250 faces a 1% base tax of $54,362.50 before levies versus the seller’s $48,000 — at least $6,362.50 more. NNN recoveries may rise with it; under a gross lease it comes out of NOI.
Tax and legal note: Apex is not a law, tax or accounting firm. Local levies vary and pass-through rights depend on each lease; consult your attorney and CPA.
How Can an Owner Increase NOI?
NOI rises only through more effective gross income or lower operating expenses.
- Cut vacancy and credit loss. Lease up space and screen tenant credit.
- Mark below-market leases at rollover. Close the contract-to-market gap at expiration.
- Recover what the lease allows. Bill and reconcile every reimbursable expense.
- Add other income. The BOE lists parking, storage, billboards and cell towers.
- Manage fixed and variable costs. Bid insurance and service contracts.
Pricing renewals and recoveries is core landlord representation work.
Common questionsNet Operating Income: Frequently Asked Questions
How do you calculate net operating income?
Start with potential gross income: annual rent at full occupancy plus reimbursements and other income. Subtract vacancy and credit loss to get effective gross income, then subtract operating expenses. What remains is NOI.
Does NOI include mortgage payments?
No. Operating expenses exclude interest and principal, so NOI is measured before debt service. Lenders then divide NOI by annual debt service, the debt service coverage ratio, to test whether the property can carry the loan.
Are property taxes included in NOI?
Yes. For investors and lenders, property taxes are an operating expense. In California, a buyer should reprice that line at the purchase price, because a purchase triggers reassessment.
Is depreciation included in net operating income?
No. Depreciation is an income tax deduction, not an operating cost, so it stays out of NOI. Under the IRS general depreciation system, the recovery period for nonresidential real property is 39 years. Apex is not a tax or accounting firm; confirm tax treatment with your CPA.
What is the difference between NOI and cash flow?
NOI is income after operating expenses but before financing. Cash flow before tax also subtracts debt service and capital and re-leasing costs such as tenant improvements and leasing commissions, so healthy NOI can coexist with thin cash flow.
What is effective gross income?
Effective gross income (EGI) is the income, including miscellaneous income, that remains after deducting vacancy and collection loss from gross income. Subtract operating expenses from it to reach NOI.
How does NOI affect a commercial property’s value?
Directly. Under direct capitalization, value equals NOI divided by a capitalization rate, so a lasting change in NOI moves value by a multiple of that change.
Start with a free property valuation built from your rent roll and operating statement.
Want a second set of eyes on a property’s NOI?
Send the rent roll or offering memo. Robert Mendieta Jr., CCIM — Associate Broker · Commercial Division, DRE #01422904 — will rebuild the NOI line by line with you.
Call Robert: (951) 977-3251Or request a free CRE consult with the form below.
Sources
These are the sources behind every figure above.
- Office of the Comptroller of the Currency · Comptroller’s Handbook, Commercial Real Estate Lending, Version 2.0 · March 2022
- California State Board of Equalization · Lesson 7 — Processing the Income Stream · accessed September 23, 2026
- California Legislative Information · California Constitution, Article XIII A · accessed September 23, 2026
- Internal Revenue Service · Publication 946, How To Depreciate Property · 2025
- CoStar · Inland Empire Industrial Market Report · Q3 2026, dated September 30, 2026
- CoStar · Inland Empire Industrial Capital Markets Report · Q3 2026, dated September 30, 2026
- CoStar · Inland Empire Retail Market Report · Q3 2026, dated September 30, 2026
- CoStar · Single-Tenant Net Lease Retail National Report, United States · Q1 2026
The worked example is hypothetical. Nothing here is investment, tax or legal advice.
Robert Mendieta Jr., CCIM · Associate Broker · Commercial Division · DRE #01422904 · Apex Real Estate Services · 3750 E. Florida Ave Suite A, Hemet, CA 92544 · (951) 977-3251 · robert@apex-res.com. Reviewed by Robert Mendieta Jr., CCIM (DRE #01422904). Last updated: October 4, 2026.