A residential income property has annual potential gross rent of $120,000. Combined vacancy and collection loss is 5% of rent, and there is no other income. All annual property expenses, including real estate taxes and reserves but excluding debt service, total $45,000. What is the annual NOI?
Correct Answer
A) $69,000
120000×(1−0.05)−45000 = 69000. Common errors: not deducting the 5% vacancy and collection loss gives $75,000; reporting EGI as NOI gives $114,000; adding the expenses instead of deducting them gives $159,000.
Why This Is the Correct Answer
Option A is correct because $120,000 × (1 − 0.05) = $114,000 EGI, and subtracting $45,000 of expenses gives $114,000 − $45,000 = $69,000 NOI.
Why the Other Options Are Wrong
Option B: $75,000
Option B, $75,000, skips the 5% vacancy and collection loss: $120,000 − $45,000 = $75,000. Deducting the loss first gives $114,000 − $45,000 = $69,000.
Option C: $114,000
Option C, $114,000, is EGI, not NOI: $120,000 × 0.95 = $114,000. The $45,000 of operating expenses must still be deducted, leaving $69,000.
Option D: $159,000
Option D, $159,000, adds the expenses instead of deducting them: $120,000 × 0.95 + $45,000 = $159,000. Expenses reduce income, so NOI is $114,000 − $45,000 = $69,000.
Gross, effective, net
Potential gross shrinks to effective gross after vacancy, then to net after expenses; each step only goes down.
How to use: Use this to sanity-check that NOI is smaller than both PGI and EGI.
Exam Tip
If your NOI answer is larger than the gross rent, you added expenses instead of subtracting them.
Common Mistakes to Avoid
- -Omitting vacancy and collection loss
- -Stopping at EGI and calling it NOI
- -Adding expenses to income
Concept Deep Dive
Analysis
This question tests building NOI from potential gross rent. Deduct the 5% vacancy and collection loss to get EGI, then subtract operating expenses. $120,000 × 0.95 = $114,000 EGI, and $114,000 − $45,000 = $69,000 NOI.
Background Knowledge
Potential gross income is the total rent a property could produce at full occupancy. Subtracting vacancy and collection loss gives effective gross income, and subtracting operating expenses gives net operating income. Debt service is not an operating expense.
Real-World Application
A fourplex has $120,000 of potential rent, a 5% vacancy and collection allowance, and $45,000 of expenses including taxes and reserves. The appraiser reconstructs the operating statement and arrives at $69,000 of NOI.
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