valuation

vacancy and collection loss

Vacancy and collection loss is an allowance subtracted from potential gross income to account for rent lost due to vacant units and tenants who do not pay. It is usually expressed as a percentage of potential gross income based on market conditions. Subtracting it, and adding any other income, produces effective gross income. This is a key step in the income approach to valuation.

Exam tip: Order of operations: potential gross income minus vacancy and collection loss plus other income = effective gross income, then minus operating expenses = net operating income.
Example: A building has potential gross income of $120,000 and a 5% vacancy rate. Vacancy and collection loss is $6,000, leaving $114,000 effective gross income.

1. A small apartment building has potential gross income of $240,000, a 6% vacancy and collection loss, operating expenses of $78,000, and annual debt service of $96,000. Using a 7.25% capitalization rate, what is the indicated value (rounded)?

Answer & explanation

Answer: C. Effective gross income is $225,600, and subtracting $78,000 in operating expenses gives NOI of $147,600; $147,600 / 0.0725 = $2,035,862. Debt service is a financing cost and is never deducted to reach NOI, so capitalizing $51,600 understates value.

Related terms & state variants

effective gross income income approach net operating income potential gross income

Sources

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Last verified: 2026-10-23