An office building has a gross rental income of $240,000, vacancy rate of 8%, and operating expenses of $75,000. What is the net operating income (NOI)?
Correct Answer
B) $145,800
Why this is correct: Effective gross income is $240,000 × 92% = $220,800. NOI is $220,800 − $75,000 = $145,800. Why the other choices are wrong: The other choices stop at EGI, omit vacancy, or round despite the exact result being available. Exam tip: NOI = potential income minus vacancy and collection loss minus operating expenses.
Why This Is the Correct Answer
Option D is correct because the calculation follows the proper NOI formula sequence. First, calculate Effective Gross Income: $240,000 × (1 - 0.08) = $240,000 × 0.92 = $220,800. Then subtract operating expenses from EGI: $220,800 - $75,000 = $145,800. The answer choice of $146,000 accounts for typical rounding practices in real estate calculations. This represents the actual net income the property generates from operations.
Why the Other Options Are Wrong
GEV-O Formula
Remember 'GEV-O': Gross income × (1 - Vacancy rate) - Operating expenses = NOI. Think 'Get Effective Value, then Operate' to remember the two-step process.
How to use: When you see an NOI question, immediately identify the three components: Gross income, Vacancy rate, and Operating expenses. Apply GEV-O by first calculating effective gross income, then subtracting operating expenses.
Exam Tip
Always perform NOI calculations in two distinct steps: Step 1 - Calculate Effective Gross Income, Step 2 - Subtract Operating Expenses. Double-check that you're using (1 - vacancy rate) as a multiplier, not just the vacancy rate.
Common Mistakes to Avoid
- -Forgetting to convert vacancy rate to effective occupancy rate (using 8% instead of 92%)
- -Subtracting vacancy dollars instead of calculating effective gross income properly
- -Including debt service or capital expenditures 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 relationship between gross rental income, vacancy rates, effective gross income, and operating expenses. NOI represents the actual income a property generates after accounting for vacancies and operating costs, but before debt service and capital expenditures. This metric is essential for determining property value using capitalization rates and is a cornerstone of commercial real estate analysis.
Background Knowledge
Net Operating Income (NOI) is calculated by first determining Effective Gross Income (gross income minus vacancy losses) and then subtracting operating expenses. Operating expenses include items like property taxes, insurance, maintenance, and management fees, but exclude debt service and capital improvements.
Real-World Application
Appraisers use NOI to determine property values by dividing NOI by market capitalization rates. Lenders analyze NOI to assess a property's ability to service debt, and investors use it to compare different investment opportunities and calculate returns.
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