A trailing-twelve statement is a record of the seller's year. Underwritten NOI is a defended forecast of yours, and the gap between them has a price.
Start from the trailing-twelve statement and adjust every line for four things: contractual versus discretionary income, collectibility, expense realism and recurrence. On the worked retail asset, T-12 NOI of $3,345k becomes an underwritten $2,606k, 77.9 per cent of the T-12. At a 6.50 per cent cap rate that is $11.37M of price, which is what a buyer pays if it capitalises the seller's year instead of its own.
Worked in full in Real Estate Fund Management by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
A trailing-twelve statement records what happened. Underwritten NOI is what the asset will produce under the new owner, on the leases that exist, with the costs a new owner will actually pay. The two diverge in predictable places: income that was never contractual, credit losses the year happened to avoid, expenses that reset on sale, and one-off items in both directions. Real Estate Fund Management sets out four quality tests for this, and the underwriting workbook that accompanies it applies them line by line. The figures below are that illustrative case.
| Line | T-12 | Adjustment | Underwritten | Value effect |
|---|---|---|---|---|
| Base rent, executed leases | 4,820 | 0 | 4,820 | 0 |
| Rent steps already signed | 0 | +96 | 96 | +1,477 |
| Expense reimbursements | 612 | -38 | 574 | -585 |
| Percentage rent | 84 | -84 | 0 | -1,292 |
| Parking, storage, other | 146 | -52 | 94 | -800 |
| One-time and event income | 71 | -71 | 0 | -1,092 |
| Vacancy and credit loss | -231 | -96 | -327 | -1,477 |
| Concessions and free rent | -64 | -58 | -122 | -892 |
| Effective gross income | 5,438 | -303 | 5,135 | |
| Property taxes | -604 | -171 | -775 | -2,631 |
| Insurance | -188 | -79 | -267 | -1,215 |
| Repairs and maintenance | -298 | -74 | -372 | -1,138 |
| Payroll | -386 | -24 | -410 | -369 |
| Utilities | -241 | -18 | -259 | -277 |
| Management fee | -152 | -11 | -163 | -169 |
| Contract services, admin | -268 | -15 | -283 | -231 |
| Legal settlement credit | 44 | -44 | 0 | -677 |
| Operating expenses | -2,093 | -436 | -2,529 | |
| Net operating income | 3,345 | -739 | 2,606 | -11,369 |
Underwritten NOI = T-12 NOI + Σ adjustments, each one defended in writing
Value effect of an adjustment = adjustment / cap rate (here × 15.38)
Excel: =SUM(T12:T12)+SUM(Adj:Adj) for NOI and =Adj/Cap per line
Contractual versus discretionary income, -$78k. Signed rent steps go in: they are contracts, not forecasts. Percentage rent comes out entirely unless there is a three-year history to support it. Other income is cut to its durable part, and reimbursements are reduced for the exclusions found when the leases were audited, because a lease described as triple net rarely recovers everything.
Collectibility and concentration, -$154k. Vacancy is set at a market level plus a credit loss read from the arrears ageing, not from a year in which nobody happened to default. Free rent is timed explicitly instead of being smoothed away.
Expense realism, -$392k. This is 53 per cent of the whole cut. Property taxes are reassessed on the sale price at the local ratio, which alone removes $171k and $2.63M of value. Insurance is a broker's quote, not last year's premium. Repairs are restored to a normal level after a T-12 that benefited from deferred maintenance. The management fee rises by $11k even on a lower underwritten EGI, because it is underwritten at a higher rate, 3.17 per cent of EGI, against the 2.80 per cent the seller's T-12 implies.
Recurring versus non-recurring, -$115k. Event income and a legal settlement booked as a credit to expenses will not happen again. Both come out, and the second is easy to miss because it sits in the expense lines and makes them look lower.
Underwritten NOI is $2,606k against $3,345k, a 22.1 per cent cut. The operating expense ratio moves from 38.5 per cent of EGI on the T-12 to 49.3 per cent underwritten. None of this is pessimism: every adjustment is either a contract, a quote or the removal of something that will not repeat.
Pay the T-12 price at 6.50 per cent, $51.46M, and the underwritten NOI gives a going-in yield of 5.06 per cent. The buyer has paid a 6.50 cap on paper and a 5.06 cap in fact.
| Cap rate | Value on T-12 NOI | Value on underwritten NOI | Overpayment |
|---|---|---|---|
| 6.00% | $55.75M | $43.43M | $12.32M |
| 6.50% | $51.46M | $40.09M | $11.37M |
| 7.00% | $47.79M | $37.23M | $10.56M |
The lower the cap rate, the more each dollar of unsupported NOI costs. In a market priced at 6.00 per cent, the $171k tax reset is worth $2.85M on its own; a buyer who leaves it in the seller's number has given that away before the first rent review.
The usual error is to adjust only what looks wrong and accept the rest. A T-12 that is materially above the underwritten figure is a warning sign in itself; the opposite, an underwritten NOI above the T-12, is the "management lift without a plan" that LPs flag. Here the underwritten figure is 77.9 per cent of the T-12, and every point of that gap has a line, a reason and an owner. The second error is to stop at NOI: the same reset taxes and insurance flow into the debt sizing, so the lender's proceeds fall with them.
The bridge, with the six-criterion quality score it feeds, is in the underwriting workbook on the free workbook page for this book. Once NOI is underwritten, the next test is cost: see how to calculate yield on cost.
T-12 NOI is the actual net operating income of the last twelve months. Underwritten NOI is the buyer's defended forecast: contractual income only, market vacancy and credit loss, expenses reset to what a new owner will pay, and one-off items removed. In the worked case the underwritten figure is $2,606k against a T-12 of $3,345k.
In many jurisdictions the sale triggers a reassessment at the purchase price times a local assessment ratio. The seller's tax bill reflects an older assessment. In the worked case the reset adds $171k a year of expense, worth $2.63M of value at a 6.50 per cent cap rate.
Usually not, unless several years of sales history support it. It depends on tenant sales above a breakpoint and can vanish in one weak year. The worked case removes the full $84k, worth $1.29M at a 6.50 per cent cap rate.
The NOI bridge is worked in the Chapter 8 underwriting workbook of Real Estate Fund Management. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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