Net operating income (NOI) is the foundational metric in commercial real estate. It's the income stream that drives valuation: divide NOI by the cap rate and you have value. But calculating NOI correctly is harder than it sounds: there are 15-20 line items where sloppy bookkeeping or sleight-of-hand can inflate or hide the true number.
NOI Components
NOI = Effective Gross Income (EGI) − Operating Expenses. EGI includes base rent, expense recoveries (real estate tax and OpEx pass-throughs), parking income, signage / antenna income, late fees, and miscellaneous. Subtract vacancy reserve (3-5% for stabilized Manhattan multifamily), collection loss reserve, and concessions. Operating expenses include real estate taxes, insurance, utilities, repairs and maintenance, management fees, payroll, leasing commissions (amortized), and reserves.
What's NOT in NOI
Capital expenditures (capex) are not deducted from NOI; they're below the line. Debt service is not deducted (NOI is unlevered). Depreciation and amortization are not deducted (NOI is pre-D&A). Income taxes are not deducted. These exclusions matter because NOI is meant to show the cash flow available to service debt and produce equity yield, before financing and tax decisions.
OpEx Normalization
Trailing-12 OpEx is the floor. Normalize by: adding back one-time items, adding forward-looking obligations (LL11 cycles, LL97 retrofit costs amortized over 5-10 years, RPIE / tax certiorari reserves), adjusting management fee to market (3-5% of EGI for institutional Manhattan multifamily), and including replacement reserve ($250-500 per unit for multifamily, $0.50-1.00/SF for office). The buyer should underwrite the normalized OpEx, not the seller's reported OpEx.
Cash NOI vs Accrual NOI
Cash NOI uses actual cash receipts and payments in the period. Accrual NOI matches revenue and expenses to the period earned/incurred, with timing adjustments. The difference matters for assets with significant free rent (which accrual recognizes ratably; cash recognizes when cash flows), straight-line rent (which accrual recognizes; cash doesn't), and prepaid items. NYC commercial real estate institutional underwriting uses accrual NOI consistently.
- Always normalize OpEx to forward-looking obligations, not just trailing-12 reported.
- Verify the rent roll against signed leases; discrepancies between the OM and the audit are common.
- For multifamily with rent stabilization, cross-check declared rents against DHCR registration.
- Skyline Properties’ broker opinion of value reports include normalized NOI for every Manhattan commercial asset.
Robert Khodadadian and Skyline Properties run NOI normalization on every NYC commercial real estate transaction. The firm has closed $976M+ in NYC commercial real estate and provides confidential broker opinion of value reports for owners weighing a sale. Email info@skylineprp.com.