An appraiser is analyzing the operating statement for a 15-year-old industrial warehouse. The owner has set aside $12,000 annually for the eventual replacement of the roof and repaving of the parking lot. For purposes of calculating stabilized net operating income, how should this $12,000 be treated?
Correct Answer
C) It is a reserve for future capital expenditures and should be excluded from the calculation of stabilized net operating income.
Replacement reserves (or capital expenditure allowances) are amounts set aside for future major replacements and are excluded from the calculation of stabilized net operating income (NOI). NOI is intended to reflect the property's ongoing, stabilized operating performance, and capital expenditures are not considered recurring operating expenses. The governing principle is that NOI is defined as effective gross income minus operating expenses, and operating expenses do not include reserves for capital replacements.
Why This Is the Correct Answer
Replacement reserves (or capital expenditure allowances) are amounts set aside for future major replacements and are excluded from the calculation of stabilized net operating income (NOI). NOI is intended to reflect the property's ongoing, stabilized operating performance, and capital expenditures are not considered recurring operating expenses. The governing principle is that NOI is defined as effective gross income minus operating expenses, and operating expenses do not include reserves for capital replacements.
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A retail property has the following annual figures: Potential Gross Income: $350,000; Vacancy and Collection Loss: 4%; Miscellaneous Income: $5,000; Operating Expenses: $102,000; and a Replacement Reserve of $15,000. What is the property's Net Operating Income (NOI)?