Put every amount on the same time basis before subtracting vacancy or expenses. An annual vacancy allowance can look larger than one month's rent without being larger than annual potential income.
Follow the income calculation in order
| Step | Meaning |
|---|---|
| Potential gross rental income (PGI) | Rent at the stated full-occupancy assumption before vacancy and collection loss |
| Less vacancy and collection loss | Income lost from vacant space and unpaid rent |
| Plus other income, if given | Additional expected receipts, such as laundry income |
| Equals effective gross income (EGI) | Income after those adjustments |
| Less operating expenses | Property operating costs supplied by the problem |
| Equals net operating income (NOI) | Operating income before debt service |
The federal income-property analysis example illustrates the sequence from scheduled rent through vacancy, operating expenses, and NOI. Terminology can vary, so check whether a problem's stated “gross income” already includes other income or vacancy adjustments.
Worked example
Assume 10 apartments, each renting for $1,200 monthly. The exercise specifies a 5% vacancy and collection allowance on potential rent, $3,600 in annual other income, and $54,000 in annual operating expenses.
- Monthly potential rent: 10 × $1,200 = $12,000.
- Annual PGI: $12,000 × 12 = $144,000.
- Annual vacancy and collection loss: $144,000 × 0.05 = $7,200.
- EGI: $144,000 − $7,200 + $3,600 = $140,400.
- NOI: $140,400 − $54,000 = $86,400.
The annual $7,200 loss is equivalent to $600 per month. Subtracting $7,200 from one month's $12,000 would mix periods and produce the wrong result.
What if the question gives a combined loss rate?
If “vacancy and collection loss” is one combined 5% allowance, deduct it once. Do not subtract 5% for vacancy and another 5% for collection loss. When separate rates or a different calculation base are supplied, follow those instructions.
Likewise, do not reduce income for vacancy a second time when the problem explicitly gives income already adjusted for vacancy. Write a short label beside each number: monthly PGI, annual EGI, or annual expense.
Which expenses belong here?
Typical operating expenses include property taxes, property insurance, management, maintenance, and owner-paid utilities. Mortgage principal and interest are debt service, which is considered separately from NOI. Do not confuse property taxes, an operating cost, with an owner's personal income taxes. Tax depreciation is also separate from this property operating-income calculation.
If a problem specifies treatment of replacement reserves or another item, follow that definition consistently. You do not need to invent omitted expenses.
Try three practice questions
- Six units rent for $1,500 per month. What is annual PGI?
- Annual PGI is $200,000, combined vacancy and collection loss is 8%, and other annual income is $5,000. What is EGI?
- Annual EGI is $189,000 and operating expenses are $69,000. Annual mortgage debt service is separately stated as $45,000. What is NOI?
Answers and explanations
- $108,000: 6 × $1,500 × 12.
- $189,000: $200,000 − $16,000 + $5,000.
- $120,000: $189,000 − $69,000. The separate debt service does not reduce NOI. Subtracting it produces a different measure.
Keep studying
See how to choose a real estate math formula and the exam-prep guide. For help, submit the course, practice-question number, and your labeled calculation. These are original study exercises.
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