My friend and I are trying to play NWN2 together. We have added the NWN2 client extension mod, and can see everyone else's multi player games when we click on join internet games. However, when either of us tries to create a game we cannot see the game in the server listing. We also have not been able to direct connect to each other.

I'm not quite sure what IP to use when trying to connect with him. we have tried 127.0.0.1:5121 as well as trying to connect via our actual PC's IP's respectively.

Are we missing a step somewhere?

Most likely you have some ports blocked on your router.
http://portforward.com/english/applications/port_forwarding/Neverwinter_Nights_2/

Don't forget if you are both playing on the same router you'll need to assign separate active ports in the game client.

127.0.0.1 is a dummy for your own PC. This IP always points to yourself. You have to connect to the IP of the other computer's network card.

To host the server you need to host it in game (The dedicated server application isn't working properly).
Ports to open on the server's host:
- 5120 through 5300 (Depends on how many players will play on your server. One port per player.)
- 6500
- 27900
- 28900

Here's further information: http://www.neverwinternights.info/players.htm#online