The subject property is a fourplex with annual EGI of $72,000 and operating expenses of $28,800. Of those expenses, $18,000 is fixed and $10,800 varies in direct proportion to EGI. The owner's annual mortgage payments are $21,000. An appraiser projects that EGI will fall 10% because of higher vacancy. What is the projected NOI?
Correct Answer
B) $37,080
EGI falls to $64,800 and variable expenses fall 10% to $9,720, while the $18,000 of fixed expenses holds, so NOI is $64,800 − $27,720 = $37,080. Mortgage payments are not an operating expense and stay out of NOI. Keeping the 40% expense ratio gives $38,880, which wrongly shrinks the fixed costs. Holding all expenses at $28,800 gives $36,000, which ignores the variable portion. Leaving the original NOI gives $43,200.
Why This Is the Correct Answer
Option B is correct because fixed expenses stay at $18,000 and variable expenses fall to $10,800 × 0.90 = $9,720. NOI is $64,800 − $27,720 = $37,080.
Why the Other Options Are Wrong
Option A: $36,000
Option A, $36,000, holds all expenses constant: $64,800 − $28,800 = $36,000. The $10,800 variable portion falls with EGI to $9,720, so NOI is $37,080.
Option C: $38,880
Option C, $38,880, keeps the 40% ratio: $64,800 × 0.60 = $38,880. That lets the fixed $18,000 shrink too; actual expenses of $27,720 give $37,080.
Option D: $43,200
Option D, $43,200, is the original NOI: $72,000 − $28,800 = $43,200. It ignores the 10% drop in EGI; the new NOI is $64,800 − $27,720 = $37,080.
Fixed stays, variable follows
When occupancy changes, leave fixed costs alone and scale variable costs with income. Then recompute NOI.
How to use: Use this split when a question changes occupancy and also gives the expense breakdown.
Exam Tip
If a problem gives a fixed and variable breakdown, expect to use it. A single ratio will not carry through an income change.
Common Mistakes to Avoid
- -Applying a constant expense ratio after occupancy changes
- -Holding variable expenses constant when income falls
- -Reducing fixed expenses in proportion to EGI
Concept Deep Dive
Analysis
An expense ratio describes one level of income and does not stay fixed when occupancy changes. Fixed costs hold steady while variable costs move with income, so the ratio rises as EGI falls. That is why NOI drops by a larger percentage than EGI.
Background Knowledge
Operating expenses are often classed as fixed, such as property insurance, or variable, which change with occupancy or use. Because of fixed expenses, NOI is more sensitive to income changes than EGI is.
Real-World Application
An appraiser analyzes a fourplex in a market where vacancy has risen. Applying the old expense ratio to lower income would understate expenses, so the appraiser rebuilds the budget from fixed and variable lines.
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