Net operating income, or NOI, is a critical metric in commercial real estate. Not just as a measure of profitability, but as a warning sign of a debt service coverage ratio that will allow a borrower to maintain payments, or not, according to Moody’s year-end NOI index report.
Moody’s looked at key collateral types for commercial mortgage-backed securities (CMBS) loans, including agency, conduit/fusion, large loan, and single asset/single borrower (SASB) deals, where data is more readily available than in many other types of CRE lending. A shift in NOI can positively or negatively affect the debt service coverage ratio (DSCR), depending on the direction of movement and assuming that expense factors are constant to make the analysis easier.
As the report noted, a DSCR of 1.30 can withstand a 23% drop in NOI before hitting break-even debt service levels. Push the DSCR to 1.60 and the resilience moves up to a 38% drop before reaching break-even. Looking at national core property data, 28.8% of loans that saw an NOI decline of 20% or less were likely able to continue maintaining debt obligations. However, 19.8% of loans, with NOI declines of more than 20%, were at “significantly elevated risk of default.”
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Within a standard deviation, two-thirds of loans saw NOI changes from -31.8% to +31.8%. The 10th percentile saw drops of at least 19.3%. At the 90th percentile, loans saw NOI growth of at least 61.1%. The specifics suggested that “while the overall distribution leans slightly toward positive outcomes, the credit implications of downside volatility remain more pronounced, underscoring the asymmetrical risk dynamics in CMBS performance.”
Apartments have done better than the industrial, office, and retail sectors (the last three combined under the term commercial) in the NOI measure. Apartment NOI only saw a “modest dip” during the financial crisis and then went on to top the pre-crisis peak by 61.5%. Core commercial property NOI hasn’t fared as well. As of December 2023, the category's NOI growth was about 26.7%, lagging about the 34.8% figure for apartments.
Approximately 46.3% of commercial properties saw declines of 40% or more; only 28.7% of apartments were the same. The difference means apartments have greater stability because they are “less susceptible to severe income disruptions compared to the broader commercial property sector.” This is particularly true for office.
Again, this assumes constant expenses, which is unrealistic in today’s market. Therefore, to practically use the approach, a more complex and nuanced analysis, considering expenses such as insurance, taxes, utilities, and maintenance, will be necessary.
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