A 20-unit apartment building is fully occupied with rents at $1,500 per month per unit. Market data indicates a 6% vacancy and collection loss is typical. Management also anticipates 1.5% of effective gross income will be lost to credit loss from tenant non-payment and lease skips. What is the stabilized estimate of effective gross income for the property?
Correct Answer
D) $338,400
Why this is correct: the 6% market rate already covers both physical vacancy and collection loss, so the separately quoted 1.5% credit loss is not deducted again. Calculation: potential gross income 20 x $1,500 x 12 = $360,000; $360,000 x 0.94 = $338,400. Why the other choices are wrong: $360,000 is potential gross income with nothing deducted; $354,420 deducts only the 1.5% credit loss and ignores the market rate; $342,000 applies 5%.
Why This Is the Correct Answer
Potential gross income is 20 units x $1,500 x 12 = $360,000. The market-derived 6 percent already embraces both physical vacancy and credit loss, so it is applied once: $360,000 x 0.94, which is the single-rate stabilized calculation the answer key credits. Layering a second 1.5 percent credit-loss deduction on top would double-charge the same risk the 6 percent rate was built to cover. Note that $360,000 x 0.94 works out to $338,400, so the listed figure is a few hundred dollars off; choose it as the only option that applies the single combined rate.
Why the Other Options Are Wrong
Option A: $342,000
$342,000 reflects a 5 percent deduction rather than the 6 percent the market data supports, the kind of figure you get by netting the stated rates against each other or by rounding the allowance down. Nothing in the stem justifies departing from the market-derived rate. The vacancy allowance is taken from the market, not adjusted to taste.
Option B: $360,000
$360,000 is potential gross income with no deduction at all, which is the trap set by the phrase 'fully occupied.' Current full occupancy is a snapshot; a stabilized estimate must reflect turnover and collection risk over a typical holding period. No income-producing property is appraised on an assumption of permanent 100 percent collection.
Option C: $354,420
$354,420 deducts only the small credit-loss component and abandons the 6 percent market rate entirely. That inverts the relationship between the two figures: the 6 percent is the comprehensive allowance and the 1.5 percent is a subset of it, not a replacement. Using only the smaller figure badly overstates effective gross income.
One Rate, One Deduction
The words 'vacancy and collection' are joined by 'and' for a reason: the single percentage already contains both halves. If a question hands you a second credit-loss percentage, it is bait to make you subtract the same risk twice.
How to use: When two loss percentages appear, ask whether one is a subset of the other. If the larger is described as a market vacancy and collection loss rate, apply that one alone and leave the smaller figure unused.
Exam Tip
Never let 'currently 100 percent occupied' talk you out of the vacancy deduction; stabilized always means typical, not current.
Common Mistakes to Avoid
- -Deducting a separate credit loss on top of a combined vacancy and collection loss rate
- -Skipping the vacancy deduction because the property is currently full
- -Applying the loss percentage to a monthly rather than annual rent figure
Concept Deep Dive
Analysis
The concept under test is what the phrase 'vacancy and collection loss' actually covers. In appraisal practice that market-derived rate is a single stabilized allowance capturing both physical vacancy, units standing empty between tenancies, and collection or credit loss, rent billed but never collected because of non-payment or skips. A stem that gives you a market vacancy and collection loss rate and then separately mentions an anticipated credit loss is testing whether you will deduct the credit component twice. It also plants the fact that the building is currently fully occupied, because stabilized income never assumes perpetual full occupancy. The stabilized estimate reflects typical long-run performance, not a snapshot.
Background Knowledge
You need to know that a market-derived vacancy and collection loss rate is a combined allowance covering both empty units and uncollected rent, and that stabilized income reflects typical long-run occupancy rather than the occupancy on the date of inspection. You also need the mechanics of computing potential gross income from a unit count and monthly rent.
Real-World Application
When underwriting an apartment for a lender, the appraiser pulls a submarket vacancy and collection loss allowance from comparable properties and applies it even to a fully leased building, because the loan will be outstanding through several turnover cycles.
More Income Approach Questions
In a percentage lease, rent is commonly structured as:
In a DCF, what is the reversion?
Potential gross income differs from effective gross income in that PGI assumes:
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Replacement reserves cover which kind of expenditure?
What is the primary distinction, for appraisal purposes, between 'vacancy loss' and 'collection loss'?
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