Archie Boone, CFA, is the managing director at Hoffman Advisors, an alternative investment management company. Boone is reviewing the work of a real estate analyst and finds that in calculating net operating income (NOI) for a property, the analyst has understated vacancy by $3,000, overstated depreciation expense by
$4,000, overstated insurance expense by $4,000, and understated interest expense by $2,000. If Boone corrects the analyst's estimates of NOI for all these items, the updated estimate will:
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A. B. C.Explanation
To determine the updated estimate of net operating income (NOI), we need to adjust the analyst's initial calculation by correcting the errors in vacancy, depreciation expense, insurance expense, and interest expense. Let's analyze each adjustment and its impact on the updated estimate:
Vacancy: The analyst understated vacancy by $3,000. Understating vacancy means that the initial NOI calculation did not account for the potential rental income lost due to unoccupied units. Therefore, correcting this error will increase the updated NOI by $3,000.
Depreciation Expense: The analyst overstated depreciation expense by $4,000. Overstating depreciation expense reduces the property's taxable income, thus decreasing the amount subject to taxes. However, NOI is calculated before deducting taxes, so correcting this error will have no direct impact on the updated NOI.
Insurance Expense: The analyst overstated insurance expense by $4,000. Overstating insurance expense means that the initial NOI calculation allocated a higher amount towards insurance costs than necessary. Correcting this error will decrease the updated NOI by $4,000.
Interest Expense: The analyst understated interest expense by $2,000. Understating interest expense means that the initial NOI calculation did not account for the full interest cost associated with financing the property. Correcting this error will decrease the updated NOI by $2,000.
Considering all the adjustments, let's calculate the net impact on the updated NOI:
Increase in NOI due to restatement of vacancy: +$3,000 Decrease in NOI due to restatement of insurance expense: -$4,000 Decrease in NOI due to restatement of interest expense: -$2,000
Net impact on the updated NOI: +$3,000 - $4,000 - $2,000 = -$3,000
Therefore, the updated estimate of NOI will decrease by $3,000. None of the given answer choices accurately reflect this outcome, so none of the provided options are correct.