A property has potential gross income of $120,000, vacancy rate of 5%, and operating expenses of $36,000. What is the net operating income (NOI)?
Correct Answer
A) $78,000
NOI = (PGI - Vacancy) - Operating Expenses: ($120,000 - $6,000) - $36,000 = $78,000. Vacancy = $120,000 × 5% = $6,000.
Why This Is the Correct Answer
Option A ($78,000) correctly follows the two-step NOI calculation process. First, calculate the vacancy loss: $120,000 × 5% = $6,000, then subtract from PGI to get Effective Gross Income: $120,000 - $6,000 = $114,000. Finally, subtract operating expenses from EGI: $114,000 - $36,000 = $78,000. This systematic approach ensures all vacancy and expense deductions are properly accounted for in determining the property's true net operating performance.
Why the Other Options Are Wrong
Option B: $84,000
Option B ($84,000) represents a calculation error where the vacancy loss was not properly deducted. This would result from subtracting only the operating expenses ($120,000 - $36,000 = $84,000) without accounting for the 5% vacancy rate, leading to an overstatement of NOI.
Option C: $114,000
Option C ($114,000) represents the Effective Gross Income (EGI), not the NOI. This error occurs when someone correctly calculates PGI minus vacancy ($120,000 - $6,000 = $114,000) but fails to subtract the operating expenses, stopping one step short of the complete NOI calculation.
Option D: $79,200
Option D ($79,200) appears to result from an incorrect vacancy calculation or mathematical error. This might occur from miscalculating the vacancy amount or applying the percentages incorrectly, demonstrating the importance of careful step-by-step calculations in income approach problems.
PEG-NO Formula
Remember 'PEG-NO': Potential Gross Income → Effective Gross Income → Net Operating Income. Think of it as 'PEG the vacancy, then NO to operating expenses.' PGI minus vacancy equals EGI, then EGI minus operating expenses equals NOI.
How to use: When you see an NOI calculation question, immediately write 'PEG-NO' and set up the two-step process: Step 1 (PEG): Calculate vacancy loss and subtract from PGI to get EGI. Step 2 (NO): Subtract operating expenses from EGI to get NOI.
Exam Tip
Always show your work in two clear steps for NOI calculations - first calculate EGI, then NOI. This prevents the common error of forgetting to deduct vacancy and helps you catch calculation mistakes before selecting your answer.
Common Mistakes to Avoid
- -Forgetting to calculate and deduct vacancy loss from PGI
- -Confusing EGI with NOI and stopping the calculation too early
- -Incorrectly calculating the vacancy amount by using wrong percentage or base amount
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. NOI represents the actual income a property generates after accounting for vacancy losses and operating expenses, but before debt service and capital expenditures. The calculation requires understanding the sequential relationship between Potential Gross Income (PGI), Effective Gross Income (EGI), and NOI. This is one of the most frequently tested concepts on appraisal exams because NOI is essential for capitalization rate calculations and overall property valuation.
Background Knowledge
The income approach to valuation relies on the property's ability to generate income, with NOI being the foundation for capitalization rate analysis. Understanding the hierarchy of income calculations (PGI → EGI → NOI) is essential for accurate property valuation and is fundamental to commercial real estate appraisal practice.
Real-World Application
Appraisers use NOI calculations daily when valuing income-producing properties like apartment buildings, office complexes, and retail centers. Lenders require accurate NOI figures to determine loan amounts, and investors use NOI to calculate cap rates and make purchase decisions.
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?
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