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?
Correct Answer
A) $102,400
Effective gross income = $180,000 × (1 - 0.07) = $167,400. NOI = $167,400 - $65,000 = $102,400.
Why This Is the Correct Answer
Option A ($102,400) correctly follows the two-step NOI calculation process. First, the Effective Gross Income is calculated by taking the Potential Gross Income of $180,000 and reducing it by the 7% vacancy and collection loss: $180,000 × (1 - 0.07) = $167,400. Then, the operating expenses of $65,000 are subtracted from the Effective Gross Income to get the final NOI: $167,400 - $65,000 = $102,400. This demonstrates proper understanding of the income approach hierarchy.
Why the Other Options Are Wrong
Option B: $115,000
$115,000 represents an error where someone subtracted the operating expenses directly from the potential gross income without first accounting for vacancy and collection losses ($180,000 - $65,000 = $115,000), skipping the critical step of calculating effective gross income.
Option C: $167,400
$167,400 is the Effective Gross Income, not the NOI. This error occurs when someone correctly calculates the vacancy and collection loss but forgets to subtract the operating expenses to arrive at the final NOI figure.
Option D: $50,000
$50,000 appears to be a calculation error, possibly from incorrectly applying the vacancy percentage or making arithmetic mistakes in the multi-step calculation process.
PEG-NO Method
Remember 'PEG-NO': Potential income, subtract Empty spaces (vacancy), get Gross effective income, subtract eNding Operational costs = Net Operating income. Think of a PEG (clothespin) holding money, but some falls out (vacancy), then you pay operating costs.
How to use: When you see an NOI question, immediately think 'PEG-NO' and follow the sequence: start with Potential income, calculate vacancy loss, find Effective gross income, then subtract Operating expenses for the final NOI.
Exam Tip
Always calculate vacancy and collection losses as a percentage of potential gross income first, then subtract operating expenses from the effective gross income - never skip the intermediate step of finding effective gross income.
Common Mistakes to Avoid
- -Subtracting operating expenses from potential gross income without first calculating effective gross income
- -Forgetting to subtract operating expenses and stopping at effective gross income
- -Calculating vacancy as a dollar amount instead of a percentage of potential gross income
Concept Deep Dive
Analysis
This question tests the fundamental income approach calculation for Net Operating Income (NOI), which is a critical metric in real estate valuation. The calculation requires understanding the sequential steps: starting with Potential Gross Income, subtracting vacancy and collection losses to get Effective Gross Income, then subtracting operating expenses to arrive at NOI. This is one of the most important calculations in commercial real estate appraisal as NOI is used to determine property value through capitalization rates. The question specifically tests whether candidates understand that vacancy losses must be calculated as a percentage of potential gross income, not as a flat dollar amount.
Background Knowledge
Net Operating Income (NOI) is calculated using the formula: NOI = Effective Gross Income - Operating Expenses, where Effective Gross Income = Potential Gross Income - Vacancy and Collection Losses. This calculation is fundamental to the income approach to valuation and is used extensively in commercial real estate analysis.
Real-World Application
Appraisers use NOI calculations daily when valuing income-producing properties like office buildings, retail centers, and apartment complexes. The NOI figure is then divided by a market-derived capitalization rate to determine the property's value using the income approach, making this calculation essential for accurate property valuations.
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