A building has potential gross income of $180,000, vacancy and collection loss of 8%, and operating expenses of $54,000. What is the net operating income?
Correct Answer
A) $111,600
Effective Gross Income = $180,000 × (1 - 0.08) = $165,600. NOI = EGI - Operating Expenses = $165,600 - $54,000 = $111,600.
Why This Is the Correct Answer
Option A correctly follows the two-step NOI calculation process. First, the Effective Gross Income is calculated by reducing the Potential Gross Income by the vacancy and collection loss: $180,000 × (1 - 0.08) = $165,600. Then, operating expenses are subtracted from the EGI to determine NOI: $165,600 - $54,000 = $111,600. This methodical approach ensures all income adjustments are properly accounted for before arriving at the net operating income figure.
Why the Other Options Are Wrong
Option B: $126,000
This answer ($126,000) represents the result of subtracting operating expenses directly from potential gross income without accounting for vacancy and collection losses ($180,000 - $54,000 = $126,000). This skips the critical step of calculating Effective Gross Income first, which overstates the actual net operating income by $14,400.
Option C: $165,600
This answer ($165,600) represents only the Effective Gross Income calculation and fails to subtract the operating expenses. While $165,600 correctly shows PGI minus vacancy and collection losses, it's incomplete as it doesn't account for the $54,000 in operating expenses that must be deducted to arrive at NOI.
Option D: $72,000
This answer ($72,000) appears to result from incorrectly calculating the vacancy loss as a dollar amount rather than a percentage, then subtracting both this amount and operating expenses from PGI. This represents a fundamental misunderstanding of how vacancy and collection losses are applied in income calculations.
PEG-NO Formula
PEG-NO: Potential becomes Effective, then Get Net Operating income. Think of a PEG (clothespin) holding NO (number) - you clip off vacancy first, then operating expenses to get your final number.
How to use: When you see an NOI question, immediately think 'PEG-NO' and follow the sequence: 1) Start with Potential Gross Income, 2) Subtract vacancy/collection losses to get Effective Gross Income, 3) Subtract operating expenses to get Net Operating income.
Exam Tip
Always perform NOI calculations in the correct sequence and double-check that you've applied vacancy as a percentage reduction, not a dollar amount, unless specifically stated otherwise.
Common Mistakes to Avoid
- -Subtracting operating expenses from PGI without first calculating EGI
- -Treating vacancy rate as a dollar amount instead of a percentage
- -Including debt service or depreciation as operating expenses in NOI calculations
Concept Deep Dive
Analysis
This question tests the fundamental income approach calculation sequence used in real estate valuation. The process involves converting Potential Gross Income (PGI) to Effective Gross Income (EGI) by accounting for vacancy and collection losses, then subtracting operating expenses to arrive at Net Operating Income (NOI). This NOI calculation is critical because it represents the actual income available to service debt and provide return on investment. Understanding this sequence is essential for appraisers as NOI is the foundation for capitalization rate calculations and property valuations using the income approach.
Background Knowledge
Net Operating Income (NOI) is calculated by starting with Potential Gross Income, adjusting for vacancy and collection losses to get Effective Gross Income, then subtracting operating expenses. Operating expenses include items like maintenance, utilities, property management, insurance, and property taxes, but exclude debt service and depreciation.
Real-World Application
Appraisers use NOI calculations when valuing income-producing properties like apartment buildings, office complexes, or retail centers. The NOI figure is then divided by a market-derived capitalization rate to estimate the property's value, making accuracy in this calculation critical for reliable appraisals.
More Math & Stats Questions
What is the area of a triangular lot with a base of 120 feet and a height of 80 feet?
An irregular lot has the following measurements: Side A = 100', Side B = 150', Side C = 120', Side D = 180'. If the lot can be divided into two rectangles (100' × 150' and 120' × 30'), what is the total area?
A property has a potential gross income of $180,000, vacancy and collection loss of 7%, and operating expenses of $65,000. What is the NOI?
A property generates $120,000 in net operating income and is valued at $1,500,000. What is the capitalization rate?
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