Hawaii Pre-Licensing National Practice Exam

To determine net operating income, which fee is deducted from effective gross income?

1. Debt service

2. Operating expenses

3. Capital expenditures

4. Management fees

The correct answer is: Operating expenses

Net operating income (NOI) is a key figure used in real estate investment analysis, representing the income generated by a property after all operating expenses have been deducted from the effective gross income (EGI). Effective gross income includes all income received from the property, such as rent and any other earnings, after accounting for vacancy and credit losses. To calculate NOI, it is essential to subtract operating expenses from EGI. Operating expenses encompass the costs necessary to keep the property running, including property management fees, maintenance, repairs, property taxes, insurance, utilities, and other routine expenditures required for property management. These costs are directly associated with the continuing operations of the property. While debt service and capital expenditures are critical considerations in an overall financial analysis of a property, they are not included in the calculation of NOI. Debt service refers to the financing costs associated with the mortgage payments, while capital expenditures are typically long-term investments for property improvements or replacements that extend the life of significant elements of the property. Therefore, operating expenses must be deducted from effective gross income to accurately determine net operating income, as they directly affect the operational profitability of the property.