A property has potential gross income of $180,000, vacancy and collection loss of 5%, and operating expenses of $54,000. What is the net operating income?
Correct Answer
A) $117,000
NOI = (PGI - Vacancy) - Operating Expenses. ($180,000 - $9,000) - $54,000 = $171,000 - $54,000 = $117,000.
Why This Is the Correct Answer
Option A ($117,000) correctly applies the NOI formula in the proper sequence. First, the vacancy loss is calculated as 5% of $180,000 = $9,000, which is subtracted from the potential gross income to get effective gross income of $171,000. Then operating expenses of $54,000 are subtracted from the effective gross income: $171,000 - $54,000 = $117,000. This follows the standard NOI calculation methodology used in real estate appraisal.
Why the Other Options Are Wrong
Option B: $126,000
Option B ($126,000) appears to subtract only the operating expenses from the potential gross income without accounting for vacancy and collection losses, resulting in $180,000 - $54,000 = $126,000. This ignores the critical step of calculating effective gross income first.
Option C: $171,000
Option C ($171,000) represents the effective gross income after vacancy losses but fails to subtract the operating expenses. This is only the intermediate step in the NOI calculation, not the final net operating income.
Option D: $135,000
Option D ($135,000) likely results from incorrectly adding the vacancy loss instead of subtracting it, or from some other computational error in the sequence of calculations. This does not follow the proper NOI calculation methodology.
PEG-NO Formula
Remember 'PEG-NO': Potential becomes Effective becomes Gross, then subtract to get Net Operating. P(otential) - V(acancy) = E(ffective), then E(ffective) - O(perating) = N(et) O(perating).
How to use: When you see an NOI question, think 'PEG-NO' and follow the two-step subtraction: first subtract vacancy from potential to get effective, then subtract operating expenses from effective to get NOI.
Exam Tip
Always calculate vacancy as a dollar amount first (percentage × potential gross income), then follow the two-step subtraction process. Double-check that you're subtracting, not adding, each component.
Common Mistakes to Avoid
- -Forgetting to subtract vacancy losses before calculating NOI
- -Adding vacancy losses instead of subtracting them
- -Including debt service or taxes as 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. NOI represents the actual income a property generates after accounting for vacancy losses and operating expenses, but before debt service and taxes. The calculation follows a specific sequence: start with Potential Gross Income, subtract vacancy and collection losses to get Effective Gross Income, then subtract operating expenses to arrive at NOI. This metric is essential for determining property value using capitalization rates and is a key component in investment analysis.
Background Knowledge
Net Operating Income is calculated using the formula: NOI = Effective Gross Income - Operating Expenses, where Effective Gross Income = Potential Gross Income - Vacancy and Collection Losses. Operating expenses include items like maintenance, utilities, insurance, and property management, but exclude debt service, depreciation, and income taxes.
Real-World Application
Appraisers use NOI to determine property values by dividing NOI by market capitalization rates. Lenders also use NOI to calculate debt service coverage ratios when underwriting commercial real estate loans, making this calculation fundamental to both valuation and financing 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?
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?
People Also Study
Valuation Principles & Procedures
25% of exam
Property Description & Analysis
20% of exam
Market Analysis & Highest/Best Use
15% of exam
USPAP (Ethics & Standards)
15% of exam
Report Writing & Compliance
10% of exam
Related Tools
Previous Question
A commercial property has potential gross income of $240,000. Recent market data indicates vacancy rates of 8%, 12%, and 6% for similar properties. Using the mean vacancy rate, what is the effective gross income?
Next Question
The following data set represents recent sale prices: $180,000, $185,000, $190,000, $195,000, $200,000. What is the range?