An appraiser is reconstructing the operating statement of a suburban office building with effective gross income of $240,000. This year's ledger lists property taxes of $34,000, insurance of $12,000, utilities of $26,000, repairs of $28,000, on-site manager wages of $18,000 and a replacement allowance of $8,000, which buyers of similar buildings also deduct. It also lists $40,000 for repaving the parking lot, charged against that allowance. What is the net operating income?
Correct Answer
B) $114,000
The recurring items total $34,000 + $12,000 + $26,000 + $28,000 + $18,000 + $8,000 = $126,000, so NOI = $240,000 − $126,000 = $114,000. The repaving is a replacement outlay that the annual allowance already provides for, so deducting it as well would count it twice and gives $74,000. Dropping the allowance gives $122,000, and dropping the manager's wages gives $132,000.
Why This Is the Correct Answer
Option B is correct because taxes, insurance, utilities, repairs, on-site wages and the allowance total $126,000, leaving NOI of $240,000 − $126,000 = $114,000. The $40,000 repaving is left out because the allowance already provides for replacing paving. Direct capitalization needs one representative year, and the annual allowance supplies that.
Why the Other Options Are Wrong
Option A: $74,000
Option A, $74,000, deducts the $40,000 repaving on top of the allowance: $240,000 − $126,000 − $40,000 = $74,000. The cost is charged against the allowance, so this counts it twice; NOI is $114,000.
Option C: $122,000
Option C, $122,000, excludes the repaving but also drops the $8,000 allowance: $240,000 − $118,000 = $122,000. Buyers of similar buildings deduct the allowance, and removing the outlay does not remove that annual provision, so NOI is $114,000.
Option D: $132,000
Option D, $132,000, omits the $18,000 on-site manager wages: $240,000 − $108,000 = $132,000. Paying someone to run the property day to day is an operating expense, so NOI is $114,000.
One bill, one deduction
If the allowance pays for the repaving, the repaving cannot also be an expense. Spread it or spend it, but do not do both.
How to use: Use this when a ledger shows both an annual allowance and a large replacement bill.
Exam Tip
Read how a large outlay is funded. If it is charged against an allowance already in the expenses, leave the outlay out and keep the allowance.
Common Mistakes to Avoid
- -Deducting both an annual allowance and the replacement it funds
- -Dropping the allowance in a year when a large replacement is paid
- -Treating wages of on-site staff as an owner cost rather than an operating expense
Concept Deep Dive
Analysis
The task is to classify ledger lines, not to run a formula. Recurring costs of operating the property stay in, while a large replacement cost is handled through the annual allowance rather than in the year it is paid. Deducting both the allowance and the outlay counts one cost twice.
Background Knowledge
Maintenance and repair preserve a property's condition, while replacing a significant component is a capital matter. In direct capitalization, those replacements are usually annualized through an allowance, because only one year's income is capitalized. Actual outlays then draw on that provision rather than becoming a second deduction.
Real-World Application
An office owner's ledger shows a large repaving bill in the same year as a normal reserve contribution. The appraiser keeps the reserve, excludes the bill and notes in the workfile that the paving is covered by the allowance so that NOI reflects a typical year.
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