Market data show that operating expenses, excluding debt service, run 38% of EGI for properties similar to the subject. The subject's annual EGI is $420,000. What is the projected annual NOI?
Correct Answer
B) $260,400
420000×(1−0.38)=260400. Common errors: reporting the expenses instead of NOI gives $159,600; reporting EGI as NOI gives $420,000; dividing by 1.38 instead of multiplying by 0.62 gives $304,348.
Why This Is the Correct Answer
Option B is correct because NOI equals EGI less operating expenses, and expenses are 38% of EGI. $420,000 × (1 − 0.38) = $420,000 × 0.62 = $260,400. Debt service is excluded, so no further deduction applies.
Why the Other Options Are Wrong
Option A: $159,600
Option A, $159,600, is the operating expense amount, not NOI: $420,000 × 0.38 = $159,600. NOI is what remains after those expenses, $420,000 × 0.62 = $260,400.
Option C: $304,348
Option C, $304,348, comes from dividing EGI by 1.38 ($420,000 ÷ 1.38 = $304,348) instead of multiplying by 0.62. The correct NOI is $420,000 × 0.62 = $260,400.
Option D: $420,000
Option D, $420,000, simply reports EGI as NOI and deducts no operating expenses. Subtracting the 38% expense share gives $420,000 × 0.62 = $260,400.
Keep the complement
If expenses take 38 cents of each income dollar, NOI keeps the other 62 cents. Multiply EGI by one minus the expense ratio.
How to use: Use this whenever an expense ratio is given as a percentage of EGI and the question asks for NOI.
Exam Tip
Check whether the answer you picked is the expense amount or the NOI; test writers place both among the options.
Common Mistakes to Avoid
- -Reporting the expense amount (EGI × ratio) as NOI
- -Dividing EGI by 1 plus the ratio instead of multiplying by 1 minus the ratio
- -Deducting debt service as if it were an operating expense
Concept Deep Dive
Analysis
This question tests converting effective gross income to net operating income using an operating expense ratio. Because expenses are 38% of EGI, NOI is the remaining 62% of EGI. Multiply EGI by (1 − 0.38) rather than reporting the expense amount or dividing by a ratio.
Background Knowledge
In income processing, potential gross income less vacancy and collection loss gives effective gross income, and EGI less operating expenses gives net operating income. An operating expense ratio expresses expenses as a percentage of EGI. Debt service is a financing cost and is not an operating expense.
Real-World Application
An appraiser reviewing a fourplex finds that comparable two- to four-unit buildings run operating expenses near a stated share of EGI. After estimating the subject's EGI, the appraiser applies the complement of that ratio to estimate NOI before capitalizing it.
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Previous Question
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Next Question
A client is considering the purchase of a fourplex for $600,000, with $150,000 in cash and a $450,000 loan with annual debt service of $30,000. The client requires a 9% first-year cash-on-cash return. What minimum annual NOI must the fourplex produce to meet this requirement?