A property has potential gross income of $120,000, vacancy and collection loss of 5%, and operating expenses of $38,000. What is the net operating income?
Correct Answer
A) $76,000
NOI = PGI - Vacancy - Operating Expenses. Effective Gross Income = $120,000 × 0.95 = $114,000. NOI = $114,000 - $38,000 = $76,000.
Why This Is the Correct Answer
Option A ($76,000) correctly follows the proper NOI calculation sequence. First, the Effective Gross Income is calculated by reducing the Potential Gross Income by the vacancy and collection loss: $120,000 × (1 - 0.05) = $114,000. Then, operating expenses are subtracted from the Effective Gross Income to arrive at NOI: $114,000 - $38,000 = $76,000. This follows the standard income approach formula used in real estate appraisal.
Why the Other Options Are Wrong
Option B: $82,000
Option B ($82,000) appears to subtract only the dollar amount of vacancy loss ($6,000) rather than calculating the full Effective Gross Income first, or it may represent an error in the operating expense calculation.
Option C: $114,000
Option C ($114,000) represents the Effective Gross Income after vacancy and collection losses but fails to subtract the operating expenses, which is a required step in calculating NOI.
Option D: $120,000
Option D ($120,000) represents the Potential Gross Income without any deductions for vacancy, collection losses, or operating expenses, completely ignoring the NOI calculation requirements.
PEG-NOI Formula
PEG-NOI: Potential income → Effective income (subtract vacancy) → Get NOI (subtract operating expenses). Think 'PEG the NOI' - you must peg down the income step by step.
How to use: When you see an NOI question, immediately think 'PEG' and work through: (1) Potential Gross Income given, (2) Calculate Effective Gross Income by subtracting vacancy/collection losses, (3) Get NOI by subtracting operating expenses from Effective Gross Income.
Exam Tip
Always calculate Effective Gross Income as an intermediate step before calculating NOI - don't try to do all deductions at once as this leads to calculation errors.
Common Mistakes to Avoid
- -Subtracting operating expenses directly from Potential Gross Income without first calculating Effective Gross Income
- -Forgetting to account for vacancy and collection losses
- -Including debt service or depreciation in operating expenses when calculating NOI
Concept Deep Dive
Analysis
This question tests the fundamental income approach calculation of Net Operating Income (NOI), which is a critical metric in real estate valuation. The calculation requires understanding the sequential flow from Potential Gross Income to Effective Gross Income (after vacancy/collection losses) and finally to NOI (after operating expenses). 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 the ability to properly account for vacancy and collection losses before deducting operating expenses.
Background Knowledge
Net Operating Income (NOI) is calculated by starting with Potential Gross Income, subtracting vacancy and collection losses to get Effective Gross Income, then subtracting operating expenses. Operating expenses include items like maintenance, utilities, insurance, and property management but exclude debt service and depreciation.
Real-World Application
Appraisers use NOI calculations daily when valuing income-producing properties like apartment buildings, office complexes, and retail centers. The NOI figure is then divided by a market-derived capitalization rate to determine the property's value using the income approach.
More Math & Stats Questions
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