Include or exclude Cap rate and DSCR in NOI?

Question

Hi,

I am budgeting for the basics for my NOI (and taxes, insurance too):

1. Repairs2. vacancy rates3. CapEx4. Property manager

All of these factor into my CoC returns, but actually should they be factored into the NOI, which I need for Cap rate and DSCR?

Fatima Martin · Answer

Good question, and this trips up a lot of people because different sources draw the line differently. Here's the cleanest way to think about it:

NOI should include:

• Repairs & maintenance — yes, this is an operating expense
• Property management fees — yes, operating expense
• Vacancy loss — yes, you should be reducing your gross income by a realistic vacancy rate before you get to NOI

NOI should exclude:

• CapEx — no, this is below the NOI line. CapEx is a balance sheet item (improving the asset), not an operating expense
• Debt service (principal & interest) — no, this is what DSCR measures separately

So the formula is: NOI = Effective Gross Income (after vacancy) − Operating Expenses (repairs, PM, taxes, insurance, etc.)

Then:

• Cap Rate = NOI ÷ Property Value
• DSCR = NOI ÷ Annual Debt Service

The reason this matters more than people realize: if you accidentally fold CapEx into your operating expenses, your NOI looks artificially low, which tanks both your cap rate and your DSCR — sometimes enough to make a perfectly fundable deal look like it doesn't qualify for a loan.

One more thing that trips people up: if you pay property taxes or insurance annually rather than monthly, make sure you're accruing 1/12 of that cost each month rather than letting it create a huge expense spike in the month it's actually paid. Otherwise your monthly NOI swings wildly and doesn't reflect the property's real performance.

Happy to walk through how this applies to your specific numbers if you want to share more detail.

Robert Rixer · Answer

CapEx is not included in NOI because it makes the property more valuable which lowers cap rate. If you have an old leaky roof, patching it (maintenance, include in NOI) does not improve the value at all. On the other hand, spending $30k to replace it with a brand new roof, in theory, makes the property $30k more valuable than the same place with the old leaky roof. Therefore its considered more of an asset and not an expense.

Alex Hunt · Answer

If it’s 5 or more units. Some lenders account for a 30% expense factor on top of tax, insurance. I would just include all of them and let the lender decide what to use so they have the full picture. Would be happy to take a look with this you!

Jacob Sherman · Answer

unfortunately if the DSCR only principal interest taxes insurance and any applicable HOA or assessments

Evan Polaski · Answer

@Harry Brooklyn, you have a pretty good list there.  You could likely break things down further, but at the end of the day, your broad categories are covering it.

As for flat percentage: I am not a big fan of that, personally.  Why?  Contractors don't really care if you are collecting $2,000/mo in rent or $500/mo in rent.  A drywall patch, mud and repaint will cost your, say, $300 regardless (I know the size of the hole matters, but your rent doesn't).  Same with replacing a cabinet or door, etc.

And of course, age of building matters too.  Older roofs, statistically, will need more repairs.  Older HVAC the same.

Maybe you have already accounted for some of this nuance with your percentages, but I see too many on these forums underwriting every deal the same, which simply isn't how it works in the real world, especially if you only have say 1 to a 100 units, where each expense has a bigger impact on the overall portfolio.

Harry Brooklyn · Answer

Hi Chris - I realized I wrote a mistake.  I know they all are important for NOI and cashflow.  What I meant was should Cap Ex and a property manager be factored into computing Cap rate and DSCR?

Cap rate is more for performance of a building, where CapEx is more for reserves.  DSCR is what a bank would calculate so I'm unsure if the bank would use CapEx and a property manager in their calculations.

I want to make sure I'm using apples-to-apples comparisons.

Evan Polaski · Answer

@Harry Brooklyn, there is a difference between NOI and cash flow.  CapEx has an impact on Cash flow, but not NOI.  Capital items are considered non-recurring items, so are non-operating.

By definition and generally accepted accounting principles (GAAP) you should not include these in NOI.

As for your DSCR and Cap rate, again, I would argue technically, they are not calculated in, but often banks will include some form of recurring capex reserve contribution into their DSCR calculation.

So, should you consider these items in the evaluation of an asset, YES!  100%.  They will effect your Cash on Cash returns,  But they are not NOI, they are below the line impacts to cash flow.  The same as interest expense and amortization impact cash flow but not NOI.  Or interest rate caps, or partnership level expenses, etc.

Chris McKay · Answer

Yes, absolutely. They're legitimate factors and expenses that must be included in any NOI calculation.

Unless you're a sell side agent and want to play with the numbers to make it seem like the property cash flows when it really doesn't. Lol.