Question

Now that we have effective gross income (EGI), we need to subtract the total operating expenses (TOE).

Previously in this chapter, we defined total operating expenses as

"The sum of all fixed and variable operating expenses and the replacement allowance cited in the appraiser's operating expense estimate."

We also stated that there are two types of operating expenses, fixed and variable. Variable expenses also includes reserves for replacement.

The appraiser is responsible for estimating appropriate operating expenses. A building owner might provide an appraiser with his or her own operating expense information for the prior year (or several years). It is possible that these operating expense figures could be inaccurate, or could include expenses that are not legitimate operating expenses. The appraiser is responsible for reconstructing the operating statement to produce a credible indication of NOI for use in the appraisal.

Example: A property owner of a 12-unit building does not spend any money on painting and decorating over a three-year period, and therefore includes no expenses for painting and decorating on his operating expense sheet that he provides to the appraiser. Prudent management would dictate that the building owner should have a painting and decorating schedule that would require periodic outlays. Therefore, the appraiser should include expenses for painting and decorating in her appraisal, even though the property owner has not recently incurred any such expenses.

After deducting operating expenses from EGI, we arrive at net operating income (NOI). The NOI is the figure we will capitalize to arrive at an indication of value.

a) True

b) False

Answer 1

To calculate NOI, subtract total operating expenses, including both fixed and variable costs, from EGI. The appraiser must estimate these costs accurately, even if they differ from the property owner's previous expenses, to ensure a reliable valuation.

Step-by-step explanation:

To determine the net operating income (NOI), we must subtract the total operating expenses (TOE) from the effective gross income (EGI). Operating expenses can be broken down into fixed and variable costs, both of which must be considered by an appraiser when estimating expenses for an appraisal.

In the context of the question, the example highlights that the appraiser should include a reserve for painting and decorating as a variable expense in the appraisal, even if the property owner has not incurred such expenses recently. Such a process ensures a credible NOI, which in turn is capitalized to estimate the property's value.