Expenses & NOI
~12 min read · Classify operating expenses, exclude debt service, and land on a clean NOI.
NOI is EGI minus OPERATING expenses — and the entire exam game is the exclusion list: no debt service, no depreciation, no income taxes, no capital expenditures. Sort the expense list correctly and the NOI computes itself.
Operating expenses: the three buckets
Fixed expenses barely vary with occupancy: property taxes, insurance. Variable expenses track occupancy and operations: management fees (a % of EGI — charged even for owner-managed buildings, because the market charges for it), utilities, payroll, repairs and maintenance, trash, landscaping, supplies. Replacement reserves: annualized allowances for short-lived components (roof, HVAC, carpets) — included as an operating line in most appraisal pro formas (state the treatment; cap-rate extraction must match it).
- Fixed: taxes, insurance
- Variable: management, utilities, maintenance, payroll
- Reserves: annualized component replacements — treatment stated
- Management imputed even when the owner self-manages
The exclusion list
NOT operating expenses: debt service (financing choice, not property performance — NOI is the unlevered number), book depreciation (accounting fiction), income taxes (owner-specific), capital expenditures/additions (handled via reserves or below the line), and owner's personal items. The exam plants these in expense lists; the skill is striking them without mercy.
- No mortgage payments — NOI is pre-debt
- No depreciation, no income taxes, no capex
- Owner-specific costs are not property costs
Ratios and reasonableness
Operating expense ratio (OER) = operating expenses ÷ EGI — benchmarked by property class (apartments commonly ~35–50%); a pro forma at 18% or 70% demands investigation. Net income ratio = NOI ÷ EGI = 1 − OER. Cross-check owner statements against market norms: owners understate to sell, overstate to appeal taxes — the appraiser reconstructs a MARKET-typical statement.
Worked example
EGI $229,944. The owner's statement lists: property taxes $21,000; insurance $8,400; utilities $13,200; repairs $11,000; management (self-managed) $0; mortgage payments $86,000; depreciation $32,000; new roof installed this year $28,000. Market management runs 5% of EGI; reserves for the property compute to $7,500/year. Build the NOI.
Strike the intruders: mortgage ($86,000) — debt service, out; depreciation ($32,000) — accounting, out; the roof ($28,000) — a capital expenditure, out (its economics enter through the $7,500 reserve line instead). Impute management: 5% × 229,944 = $11,497 — the market charges it even if the owner works free. Operating expenses: 21,000 + 8,400 + 13,200 + 11,000 + 11,497 + 7,500 = $72,597. NOI = 229,944 − 72,597 = $157,347. OER = 72,597 ÷ 229,944 ≈ 31.6% — lean but plausible for the class. The owner's statement said $199,600 of 'expenses'; the market statement says $72,597 — reconstructing that gap is the appraiser's job.
Common exam pitfalls
Letting debt service into operating expenses.
NOI is unlevered — financing lives below the line, in the investor's DCF, never in NOI.
Accepting $0 management for owner-run buildings.
Impute market-rate management — the buyer will pay for it, so the value must.
Expensing capital items in full.
Capex flows through annualized reserves (treatment stated), not as a one-year expense crater.
Taxes and insurance fixed, operations variable, reserves steady — and the mortgage, the depreciation, and the IRS never touch NOI.
Recap
- Operating expenses: fixed + variable + (stated) reserves
- Impute market management always
- Excluded: debt service, depreciation, income taxes, capex
- NOI = EGI − operating expenses
- OER benchmarks the pro forma's honesty
- Reconstruct owner statements to market-typical
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