A property's effective gross income is $180,000 with a vacancy rate of 5%. Operating expenses are $65,000. What is the net operating income?
Correct Answer
A) $115,000
Why this is correct: Net Operating Income (NOI) = Effective Gross Income (EGI) - Operating Expenses. The stem states EGI is $180,000, which is the income after vacancy and collection loss. Therefore, NOI = $180,000 - $65,000 = $115,000. Why the other choices are wrong: "$124,000" might result from incorrectly subtracting expenses from potential gross income. "$171,000" results from subtracting vacancy (5% of $180,000 is $9,000) from EGI, which is a double count. "$106,000" might result from miscalculating vacancy from a different base. Exam tip: If the problem gives you 'Effective Gross Income,' vacancy has already been accounted for. NOI = EGI - OpEx.
Why This Is the Correct Answer
Option A ($115,000) is correct because the calculation properly recognizes that effective gross income already accounts for vacancy losses. Since we start with effective gross income of $180,000, we simply subtract the operating expenses of $65,000 to get NOI. The formula is: NOI = Effective Gross Income - Operating Expenses = $180,000 - $65,000 = $115,000.
Why the Other Options Are Wrong
Option B: $124,000
Option B ($124,000) appears to subtract only a portion of the operating expenses, possibly confusing operating expenses with other expense categories or making an arithmetic error in the calculation process.
Option C: $171,000
Option C ($171,000) incorrectly subtracts only the vacancy amount ($9,000) from the effective gross income instead of subtracting the full operating expenses. This demonstrates a fundamental misunderstanding of the NOI calculation.
Option D: $106,000
Option D ($106,000) incorrectly applies the 5% vacancy rate to the effective gross income, double-counting the vacancy adjustment. This suggests confusion between potential gross income and effective gross income calculations.
EGI-NOI Direct Path
Remember 'EGI to NOI = Subtract OE' (Effective Gross Income to Net Operating Income equals subtract Operating Expenses). Think of EGI as 'money in the door' and NOI as 'money after bills.'
How to use: When you see 'effective gross income' in a problem, immediately recognize that vacancy is already handled - go straight to subtracting operating expenses without any further vacancy calculations.
Exam Tip
Always identify whether the problem gives you 'potential gross income' or 'effective gross income' first - this determines whether you need to calculate vacancy losses or can proceed directly to operating expense deduction.
Common Mistakes to Avoid
- -Double-counting vacancy when effective gross income is already given
- -Confusing potential gross income with effective gross income
- -Including debt service or depreciation in operating expenses
Concept Deep Dive
Analysis
This question tests understanding of the income approach calculation sequence and the critical distinction between potential gross income and effective gross income. Effective gross income is the rental income after vacancy and collection losses have been deducted, representing the actual income the property generates. Net Operating Income (NOI) is calculated by subtracting operating expenses from effective gross income, and is a fundamental metric used in property valuation and investment analysis.
Background Knowledge
The income approach requires understanding the hierarchy: Potential Gross Income → Effective Gross Income (after vacancy/collection losses) → Net Operating Income (after operating expenses). Operating expenses include property taxes, insurance, maintenance, management fees, and utilities, but exclude debt service and depreciation.
Real-World Application
Appraisers use NOI to determine property values through capitalization rates (Value = NOI ÷ Cap Rate). Accurate NOI calculation is essential for investment analysis, loan underwriting, and property valuation in commercial real estate transactions.
More Income Approach Questions
A property generates $85,000 in Net Operating Income and sells for $1,062,500. What is the overall capitalization rate?
A property has potential gross income of $180,000, vacancy and collection loss of $15,000, and operating expenses of $65,000. What is the Net Operating Income?
A comparable sale occurred 8 months ago for $425,000. Market conditions indicate property values have increased 0.5% per month since that time. What is the adjusted sale price?
A property generates $150,000 in potential gross income. Market data indicates a 7% vacancy rate and operating expenses of 35% of effective gross income. If the cap rate is 9.5%, what is the indicated value?
A property sold for $320,000 one year ago. If market conditions have improved by 6% since that sale, what is the time-adjusted sale price for comparison purposes?
A commercial building cost $2,500,000 to construct. The land value is $600,000. If the building has suffered 15% physical deterioration and 8% functional obsolescence, what is the depreciated cost of the improvements?
A building's gross rent multiplier (GRM) is 120. If the monthly rent is $2,500, what is the indicated value?
In the cost approach, economic obsolescence is characterized as:
The concept of regression in property values means that:
A commercial property has potential gross income of $120,000, vacancy and collection loss of 8%, and operating expenses of $35,000. Using a cap rate of 9.5%, what is the indicated value?
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