To acquire commercial real estate, prospective borrowers undergo an underwriting process. Investment property underwriting allows lenders to assess the profitability of a property as well as the risk of borrowers and therefore, whether they should approve a given commercial loan request. The factors involved in underwriting help to determine loan amounts, terms, and amortizations, so it’s an important process for those seeking commercial financing to understand as it gives insight as to how lenders calculate this income. The three primary aspects of underwriting include reviewing the loan-to-value (LTV) ratio, analyzing net operating income (NOI), and calculating the debt service coverage (DSCR). Here, we’ll discuss one part of this process: what NOI means and how to calculate it.

Understanding Net Operating Income (NOI)
Net operating income, commonly referred to as NOI, is a calculation that allows investors and lenders to understand how much money is made from a specified commercial property. 99% of the time, the NOI used by lenders is less than the actual NOI generated and collected by investors. This is a common calculation used by lenders to mitigate risk and over lending into properties.

NOI is used to analyze profitability and is calculated based on before-tax revenues. NOI can be used to project profit over different periods of time, such as yearly and monthly. These calculations can also include any revenue that’s generated from amenities on site, such as parking, vending machines, laundry, cell towers, billboards, et cetera. Net operating income of a commercial property is important and has a direct impact on the financing process along with cash flow for investors.

Understanding the implications of NOI is straightforward. When a commercial property has a total income that surpasses its expenses, the NOI will be positive. When the expenses surpass the income, the NOI will be negative and is unlikely to receive positive attention from lenders but could still be a great investment depending on other factors seen or valued by the investor. These are typically properties that are positioned to be improved or turned around.

How to Calculate NOI
Determining NOI is one of the more-straight forward calculations in the underwriting process. To begin, you take the total commercial real estate income and subtract the total operating expenses. The result is your net operating income or NOI.

To make sure you’re calculating NOI accurately, you need to be aware of what constitutes both income and expenses.

What’s Included in Total Income
The total income of a property includes all rental income and associated service fees. If you have parking structures on the commercial property that charge visitors, vending machines, storage fees, billboards, cell towers, or any other fees, be sure to include this in your total income calculations. Some lenders will use discretion in how they include these additional income streams, but from an investor’s perspective, this is actual income.

Since future rental income can be variable, the borrower typically needs to submit a current rent roll to demonstrate total current income. It is important to note that lenders may adjust the total income calculation based on vacancy or credit loss, which can depend on current market conditions, location or rollover risk.

How to Determine Total Operating Expenses
Total operating expenses do not include all expenses that are related to commercial properties. They only cover the costs that are associated with running and maintaining a commercial property. For example, you would not include your mortgage payments when you calculate NOI as they are not considered operating expenses. Interest paid on mortgages is also excluded.

Operating expenses include the general administrative cost of operating a commercial property, property management fees, insurance premiums, repairs and maintenance, utilities, property taxes, janitorial services, and legal fees.

How NOI Affects Underwriting
Analyzing the net operating income of a commercial property is important because it allows lenders to understand the income, after all expenses are paid, of a specific property. While it’s not the sole determining factor when deciding whether to provide commercial financing, it is used to complete more complex calculations like the debt service coverage (DSCR) and debt yield. This allows lenders and investors to better understand the future implications of approving a loan for each commercial property in question.

PACT Capital is a leading national mortgage banking firm that specializes in Multifamily, Commercial (owner-user and investor) and Agriculture Real Estate financing. We advise real estate owners and operators on how to unlock liquidity and maximize their investments through best-in-market financing ranging from $1 Million to $250 Million. PACT Capital’s team of commercial real estate advisors have developed a network of long-term lender relationships, which allow us to provide competitive options for borrowers.

To learn more, email info@PACTCap.com, or call 213-799-PACT (7228) today.