A rental property has gross annual income of $120,000, vacancy and collection loss of 5%, and operating expenses of $35,000. What is the Net Operating Income?
Correct Answer
B) $79,000
NOI calculation: Gross Income ($120,000) - Vacancy Loss ($120,000 × 5% = $6,000) - Operating Expenses ($35,000) = $120,000 - $6,000 - $35,000 = $79,000.
Why This Is the Correct Answer
Option B ($79,000) correctly applies the NOI formula by following the proper sequence of deductions. First, the vacancy loss is calculated as $120,000 × 5% = $6,000, giving an effective gross income of $114,000. Then operating expenses of $35,000 are subtracted from the effective gross income: $114,000 - $35,000 = $79,000. This represents the true net operating income available to the property owner before debt service and income taxes.
Why the Other Options Are Wrong
Option A: $85,000
Option A ($85,000) incorrectly omits the vacancy and collection loss from the calculation, only subtracting operating expenses from gross income ($120,000 - $35,000 = $85,000).
Option C: $114,000
Option C ($114,000) only accounts for vacancy and collection loss but fails to subtract operating expenses, representing effective gross income rather than net operating income.
Option D: $120,000
Option D ($120,000) represents the gross annual income with no deductions applied, ignoring both vacancy losses and operating expenses entirely.
GIVE Method
G-I-V-E: Gross Income, subtract Vacancy, subtract Expenses = NOI. Remember 'GIVE me the NOI' - you GIVE up vacancy losses and expenses to get your true operating income.
How to use: When you see an NOI calculation question, immediately think 'GIVE' and work through: identify Gross income, subtract Vacancy losses, subtract Expenses to reach your final NOI answer.
Exam Tip
Always calculate vacancy loss as a dollar amount first (percentage × gross income), then subtract both vacancy loss and operating expenses in sequence - don't try to combine the percentages.
Common Mistakes to Avoid
- -Forgetting to convert vacancy percentage to dollar amount before subtracting
- -Subtracting operating expenses from gross income without first accounting for vacancy loss
- -Including debt service or depreciation as operating expenses in NOI calculations
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. Understanding NOI calculation is essential because it's used in capitalization rate formulas, cash flow analysis, and property valuation methods. The calculation follows a specific sequence: start with gross income, subtract vacancy and collection losses to get effective gross income, then subtract operating expenses to arrive at NOI.
Background Knowledge
Net Operating Income is calculated by starting with gross potential income, subtracting vacancy and collection losses to get effective gross income, then subtracting operating expenses. Operating expenses include items like property taxes, insurance, maintenance, management fees, and utilities, but exclude debt service, depreciation, and income taxes.
Real-World Application
Appraisers use NOI to determine property values using capitalization rates (Value = NOI ÷ Cap Rate), compare investment properties, and analyze cash flow for investors and lenders in financing decisions.
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