An appraiser projects annual potential rental income of $240,000, with vacancy and collection loss of 8% of that income and no other income. Annual property expenses, including all reserves and excluding debt service, are $75,000. What is the annual NOI?
Correct Answer
A) $145,800
240000×(1−0.08)−75000 = 145800. Common errors: not deducting the vacancy and collection loss gives $165,000; reporting EGI as NOI gives $220,800; adding the expenses instead of deducting them gives $295,800.
Why This Is the Correct Answer
Option A is correct because EGI is $240,000 × 0.92 = $220,800, and $220,800 − $75,000 = $145,800. NOI is effective gross income less operating expenses, before debt service.
Why the Other Options Are Wrong
Option B: $165,000
Option B, $165,000, results from subtracting expenses directly from potential income ($240,000 − $75,000) without deducting the 8% vacancy and collection loss. The correct NOI is $220,800 − $75,000 = $145,800.
Option C: $220,800
Option C, $220,800, is the EGI ($240,000 × 0.92) reported as NOI, with the $75,000 of expenses never deducted. NOI is $145,800.
Option D: $295,800
Option D, $295,800, comes from adding the $75,000 of expenses to EGI ($220,800 + $75,000) instead of subtracting them. The correct NOI is $145,800.
Lose, then spend
First lose the vacancy from potential rent, then spend the operating expenses; the remainder is NOI.
How to use: Use this order whenever you compute NOI from potential gross income.
Exam Tip
Intermediate figures like EGI often appear as answer choices; confirm you finished every deduction.
Common Mistakes to Avoid
- -Skipping the vacancy deduction
- -Reporting EGI as NOI
- -Adding expenses instead of subtracting them
Concept Deep Dive
Analysis
This question tests moving from potential income to NOI. Reduce potential rent by the 8% vacancy and collection loss to get EGI, then deduct operating expenses; debt service is excluded and there is no other income.
Background Knowledge
The reconstructed operating statement moves from potential gross income, to effective gross income after vacancy and collection loss, to net operating income after operating expenses. Debt service is a financing cost and is not an operating expense.
Real-World Application
An appraiser reconstructs a small office building's operating statement, replacing the owner's figures with market vacancy and typical expenses, including reserves, to arrive at a stabilized NOI.
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