A property has gross rental income of $120,000, vacancy and collection loss of $6,000, and operating expenses of $45,000. What is the net operating income?
Correct Answer
B) $69,000
Why this is correct: Net Operating Income (NOI) = Gross Income - Vacancy & Collection Loss - Operating Expenses. Calculation: $120,000 - $6,000 = $114,000 (Effective Gross Income). Then $114,000 - $45,000 = $69,000 NOI. Why the other choices are wrong: $165,000 incorrectly adds expenses. $75,000 might forget to subtract vacancy. $114,000 is the Effective Gross Income, not the NOI. Exam tip: NOI is before debt service and income taxes. Memorize: NOI = GI - V&C - OE.
Why This Is the Correct Answer
Option A ($69,000) correctly applies the NOI formula by systematically deducting both vacancy/collection losses and operating expenses from gross rental income. The calculation follows the proper sequence: $120,000 (gross rental income) - $6,000 (vacancy & collection loss) - $45,000 (operating expenses) = $69,000. This represents the actual net income the property generates before debt service, which is the true measure of a property's income-producing capability. This figure would then be used with a capitalization rate to determine property value in the income approach.
Why the Other Options Are Wrong
Option A: $165,000
Option A ($165,000) incorrectly adds the vacancy/collection loss and operating expenses to the gross rental income ($120,000 + $6,000 + $45,000 = $165,000), which is mathematically and conceptually wrong. Both vacancy losses and operating expenses reduce income and should be subtracted, not added, making this answer demonstrate a fundamental misunderstanding of the NOI calculation.
Option C: $75,000
Option C ($75,000) incorrectly calculates NOI by only subtracting operating expenses from gross rental income ($120,000 - $45,000 = $75,000) while completely ignoring the vacancy and collection loss of $6,000. This is a critical error because vacancy and collection losses represent real income reduction that must be accounted for in determining the property's actual net operating income.
Option D: $114,000
Option D ($114,000) incorrectly calculates by only subtracting the vacancy and collection loss from gross rental income ($120,000 - $6,000 = $114,000) while completely ignoring the operating expenses of $45,000. This represents effective gross income, not net operating income, and fails to account for the significant operating costs required to maintain and operate the property.
GROVE Method
GROVE: Gross Rental income minus Vacancy/collection losses minus Operating expenses equals Net operating income. Think of a 'grove' of trees where you start with all the trees (gross income), some fall down (vacancy), some need maintenance costs (operating expenses), and what's left standing is your net result.
How to use: When you see an NOI calculation question, immediately write 'GROVE' and set up the formula: Gross - Vacancy - Operating = Net. This ensures you don't forget any component and maintain the correct order of operations.
Exam Tip
Always double-check that you're subtracting (not adding) both vacancy losses and operating expenses from gross income. Write out the formula before plugging in numbers to avoid calculation errors.
Common Mistakes to Avoid
- -Adding instead of subtracting vacancy losses or operating expenses
- -Forgetting to subtract one component (either vacancy or operating expenses)
- -Including debt service or depreciation in operating expenses
Concept Deep Dive
Analysis
Net Operating Income (NOI) is a fundamental calculation in real estate valuation that measures the actual income a property generates after accounting for vacancy losses and operating expenses. This metric is crucial for the income approach to valuation, as it represents the stabilized income stream available to service debt and provide return to equity investors. The calculation follows a specific order: start with gross rental income, subtract vacancy and collection losses to get effective gross income, then subtract operating expenses to arrive at NOI. Understanding this calculation is essential for appraisers as NOI is used in capitalization rate analysis and discounted cash flow models.
Background Knowledge
Net Operating Income is calculated by taking gross rental income, subtracting vacancy and collection losses to get effective gross income, then subtracting operating expenses. Operating expenses include items like property taxes, insurance, maintenance, management fees, and utilities, but exclude debt service and depreciation. NOI is the key metric used in income capitalization and represents the income available before financing costs.
Real-World Application
Appraisers use NOI calculations when valuing income-producing properties like apartment buildings, office complexes, and retail centers. The NOI is then divided by a market-derived capitalization rate to determine property value, making accurate NOI calculation critical for reliable valuations.
More Income Approach Questions
A property generates $85,000 in Net Operating Income and sells for $1,062,500. What is the overall capitalization rate?
A property has potential gross income of $180,000, vacancy and collection loss of $15,000, and operating expenses of $65,000. What is the Net Operating Income?
A comparable sale occurred 8 months ago for $425,000. Market conditions indicate property values have increased 0.5% per month since that time. What is the adjusted sale price?
A property generates $150,000 in potential gross income. Market data indicates a 7% vacancy rate and operating expenses of 35% of effective gross income. If the cap rate is 9.5%, what is the indicated value?
A property sold for $320,000 one year ago. If market conditions have improved by 6% since that sale, what is the time-adjusted sale price for comparison purposes?
A commercial building cost $2,500,000 to construct. The land value is $600,000. If the building has suffered 15% physical deterioration and 8% functional obsolescence, what is the depreciated cost of the improvements?
A building's gross rent multiplier (GRM) is 120. If the monthly rent is $2,500, what is the indicated value?
In the cost approach, economic obsolescence is characterized as:
The concept of regression in property values means that:
A commercial property has potential gross income of $120,000, vacancy and collection loss of 8%, and operating expenses of $35,000. Using a cap rate of 9.5%, what is the indicated value?
People Also Study
Real Estate Market
13.6% of exam
Property Description
11.8% of exam
Land or Site Valuation
4.5% of exam
Sales Comparison Approach
16.4% of exam
Cost Approach
13.6% of exam