A property has potential gross income of $150,000, vacancy and collection loss of 5%, and operating expenses of $45,000. What is the net operating income?
Correct Answer
B) $97,500
NOI = PGI - vacancy - operating expenses. Effective gross income = $150,000 - (5% × $150,000) = $142,500. NOI = $142,500 - $45,000 = $97,500.
Why This Is the Correct Answer
Option B correctly follows the two-step NOI calculation process. First, calculate Effective Gross Income by subtracting vacancy and collection loss: $150,000 - ($150,000 × 0.05) = $150,000 - $7,500 = $142,500. Second, subtract operating expenses from EGI to get NOI: $142,500 - $45,000 = $97,500. This methodical approach ensures all income adjustments are properly accounted for before arriving at the net operating income figure.
Why the Other Options Are Wrong
Option A: $105,000
This answer incorrectly subtracts operating expenses directly from potential gross income ($150,000 - $45,000 = $105,000) without first accounting for the 5% vacancy and collection loss, overstating the actual net operating income by $7,500.
Option C: $142,500
This represents the Effective Gross Income ($142,500) but fails to subtract the operating expenses, which is a required step to calculate Net Operating Income.
Option D: $100,000
This answer appears to use an incorrect vacancy calculation or mathematical error, possibly calculating vacancy as $5,000 instead of $7,500, resulting in NOI of $100,000 instead of the correct $97,500.
PEG-NOI Formula
Remember 'PEG-NOI': Potential income → Effective income (subtract vacancy) → Gross operating income → Net Operating Income (subtract expenses). Think of a clothesline: PGI hangs first, then you remove (vacancy), then you remove again (expenses) to get to NOI.
How to use: When you see an NOI question, immediately write 'PGI - V&C = EGI, then EGI - OpEx = NOI' and fill in the numbers step by step to avoid skipping the vacancy calculation.
Exam Tip
Always calculate Effective Gross Income as an intermediate step before calculating NOI - don't try to do it all in one calculation as this leads to errors.
Common Mistakes to Avoid
- -Forgetting to subtract vacancy and collection loss before calculating NOI
- -Confusing Effective Gross Income with Net Operating Income
- -Including debt service or depreciation in operating expenses
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 to Net Operating Income. Students must properly account for vacancy and collection losses before subtracting operating expenses. 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 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 property taxes, insurance, maintenance, and management fees, but exclude debt service and depreciation.
Real-World Application
Appraisers use NOI calculations when valuing income-producing properties like apartment buildings or office complexes, as NOI divided by the capitalization rate gives the property's estimated value using the income approach.
More Math & Stats Questions
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