Net Operating Income (NOI) in alternative investment is usually used in property value calculation. Also, a lot of data is usually given in this type of questions. Don’t be scared by the information given. It should be pretty easy in Level 1. All you have to do is to remember several steps in the calculation and you can earn these points easily (remember, 1 or 2 points can change you fate from not pass to pass!)

NOI, of course, is (income – expenses). What you have to determine is what the expenses are. Expenses include the followings:

Insurance, property taxes, promotion, repairs etc

However, there are other expenses which should not be counted! 1) Investor’s Personal tax and 2) financial cost. Why? This is because NOI is for evaluating the value of the property. So, it is irrelevant to the investor’s ability to raise fund.

The last trap is the vacancy rate. Since usually the rental income is quoted assuming all the apartments are rented (gross), you have to take the vacancy rate into account.

So, please understand the following equation and read the example, then you will be in a pretty good shape to gain the points!

NOI = (Gross Rental Income) (1 – vacancy rate) – Operating Expenses

E.g. An investor is considering buying an asset. The asset causes $30 million. The investor will do a down payment of $200k. Financial cost is 11% per year. There are 100 apartments, which can be rented for, on average, $1000 per month. The insurance is $100k a year and the maintenance fee is expected to be $90k a year. The investor is in the 35% tax bracket and the property tax is about $300k a year. Assume the vacancy rate is 10%. Calculate the NOI.

A lot of information! Recognize this and don’t be scared and you are almost done. It is asking NOI. So stay still and find the Gross income (100x$1000×12 = $1.2 million). Then find the operating expenses ($100k + $90k + $300k = $490k). Now, use the given equation:

NOI = $1200k x (1-0.1) – $490k = $590k

Again, don’t be inundated by the irrelevant data!