How Does Your Bank Calculate NOI?

When analyzing commercial real estate, most banks present columns with NOI listed for historical periods along with a column of pro forma or "underwriting" NOI.  Pro forma NOI is often calculated using “Potential Gross Income” (representing gross rents as if the property were 100% leased) less a vacancy factor.

In pro forma analyses, appraisers and banks often apply replacement reserve factors as well.  Recent appraisals may contain an appropriate vacancy factors, management fees, and replacement reserve assumptions to use in your analysis.

Your bank’s loan policy may also dictate standard amounts to use for vacancy, bad debt, replacement reserves, and management fees in the pro forma analyses.  If your bank has a policy on how to calculate pro forma or "underwriting" NOI, then I'd like to hear about it.  Feel free to leave a comment about how you make the calculation and which expenses are included and excluded.

Adding back Rent in the Debt Service Coverage Ratio

Often, the building where a business operates is owned separately from the business, itself.  The company-owner will typically own the building individually or through an LLC and lease it to the business.

In such an instance, the rent paid to company-owners (either directly or via LLC or other organization) is typically added back to the numerator of the debt service coverage ratio, while the debt service on the property is included in the denominator.

The cash flows of the company are effectively paying the debt service on the property, regardless of the paper trail.  To perform a full and proper debt service coverage analysis, you include the debt service on the mortgage in the denominator and, correspondingly, add back related rent to the numerator.  (Remember, if you include either rent in the numerator or mortgage debt service in the denominator, then you must include the other as well.)

Sometimes it is only appropriate to add back a portion of the total rent:

Example 1: If the total rent is comprised of rents for various properties, you will only add back the rent portion for the properties also owned by the owner of the company, since only that portion is included as debt service.

Example 2: The owner may effectively be distributing income to himself from the company through excessive rent.  If the rent paid by the company is significantly more than the debt service for the given property, then it may be appropriate to add back only the amount of rent necessary for debt service for the property.

Example 3: If a portion of the rent includes cash expenses such as taxes or insurance, then the amounts of each of these expenses should not be added back.  Do not add back rent unless you obtain a financial statement or lease or verify that the rent added back does not include such expenses.

Note also that you should add back rent paid to owners and consider the corresponding debt service even if the loan is from a different bank.  You also add back rent when the company had been renting but is now buying a facility.