A property has potential gross income of $120,000, vacancy and collection losses of 8%, and operating expenses of $35,000. What is the net operating income?
Correct Answer
A) $75,400
NOI = PGI - Vacancy - Operating Expenses. Effective gross income = $120,000 - (8% × $120,000) = $110,400. NOI = $110,400 - $35,000 = $75,400.
Why This Is the Correct Answer
Option A correctly applies the two-step NOI calculation process. First, the Effective Gross Income is calculated by subtracting vacancy and collection losses from PGI: $120,000 - ($120,000 × 0.08) = $120,000 - $9,600 = $110,400. Then, operating expenses are subtracted from EGI to determine NOI: $110,400 - $35,000 = $75,400. This follows the standard formula: NOI = PGI - Vacancy & Collection Losses - Operating Expenses.
Why the Other Options Are Wrong
Option B: $85,000
This answer ($85,000) appears to subtract only the operating expenses from PGI without accounting for vacancy and collection losses: $120,000 - $35,000 = $85,000. This skips the critical step of calculating Effective Gross Income first.
Option C: $110,400
This answer ($110,400) represents the Effective Gross Income, not the Net Operating Income. The calculation stops after deducting vacancy and collection losses but fails to subtract the operating expenses of $35,000.
Option D: $76,000
This answer ($76,000) suggests an incorrect calculation method, possibly subtracting a flat $44,000 from PGI instead of properly calculating the 8% vacancy loss first and then subtracting operating expenses separately.
PEG-NOI Formula
Remember 'PEG-NOI': Potential becomes Effective, then Gets NOI. P(otential) - V(acancy) = E(ffective), then E(ffective) - G(ross expenses) = NOI.
How to use: When you see an NOI calculation question, think 'PEG-NOI' and follow the two steps: first convert potential to effective income by removing vacancy losses, then subtract operating expenses to get NOI.
Exam Tip
Always perform NOI calculations in two distinct steps rather than trying to do it all at once - this prevents calculation errors and ensures you don't skip the vacancy/collection loss deduction.
Common Mistakes to Avoid
- -Forgetting to calculate vacancy and collection losses as a percentage of PGI
- -Subtracting operating expenses directly from PGI without first determining EGI
- -Confusing Effective Gross Income with Net Operating Income
Concept Deep Dive
Analysis
This question tests the fundamental income approach calculation for determining Net Operating Income (NOI), which is a critical metric in real estate valuation. The calculation requires understanding the relationship between Potential Gross Income (PGI), Effective Gross Income (EGI), and NOI. Students must recognize that vacancy and collection losses are deducted from PGI to arrive at EGI, and then operating expenses are subtracted from EGI to determine NOI. This is a foundational concept that appears frequently on appraisal exams and forms the basis for capitalization rate calculations in the income approach.
Background Knowledge
Net Operating Income is the income remaining after deducting vacancy, collection losses, and operating expenses from a property's potential gross income. It represents the actual income available to service debt and provide return on investment, making it essential for property valuation using the income approach.
Real-World Application
Appraisers use NOI calculations daily when valuing income-producing properties like apartment buildings, office complexes, and retail centers, as NOI divided by the capitalization rate determines property value in the income approach.
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?
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?
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