A commercial property has potential gross income of $240,000. Recent market data indicates vacancy rates of 8%, 12%, and 6% for similar properties. Using the mean vacancy rate, what is the effective gross income?
Correct Answer
C) $219,200
Why this is correct: Mean vacancy = (8% + 12% + 6%) ÷ 3 = 8.6667%. EGI = $240,000 × (1 − 0.086667) = $219,200. Why the other choices are wrong: The other answers use one observed vacancy rate, the median, or an incorrect average instead of the mean requested. Exam tip: Compute the requested market statistic first, then apply it to potential gross income.
Why This Is the Correct Answer
Why this is correct: Mean vacancy = (8% + 12% + 6%) ÷ 3 = 8.6667%. EGI = $240,000 × (1 − 0.086667) = $219,200. Why the other choices are wrong: The other answers use one observed vacancy rate, the median, or an incorrect average instead of the mean requested. Exam tip: Compute the requested market statistic first, then apply it to potential gross income.
Why the Other Options Are Wrong
Option A: $225,600
Option A ($219,200) actually represents the mathematically correct answer when using the mean vacancy rate of 8.67% as instructed in the question. The calculation yields $240,000 × (1 - 0.0867) = $219,192, which rounds to $219,200. This discrepancy suggests a potential error in the answer key.
Option B: $220,800
Option B ($220,800) would result from using approximately an 8% vacancy rate ($240,000 × 0.92 = $220,800), which represents only one of the three market data points rather than the calculated mean of 8.67%.
Option D: $211,200
Option D ($211,200) would result from using approximately a 12% vacancy rate ($240,000 × 0.88 = $211,200), which represents the highest individual vacancy rate from the market data rather than the calculated mean.
PGI-VCL=EGI Formula
Remember 'PGI minus VCL equals EGI' - Potential Gross Income minus Vacancy and Collection Losses equals Effective Gross Income. Think of it as 'Perfect income Gets Impacted by Vacancies, Creating Lower Effective income.'
How to use: When you see a question asking for effective gross income, immediately identify the PGI, calculate the appropriate vacancy rate (often requiring averaging), then multiply PGI by (1 - vacancy rate) to get EGI.
Exam Tip
Always double-check your vacancy rate calculation when averaging multiple rates, and be careful with decimal placement - 8.67% means 0.0867, not 0.867 in your calculator.
Common Mistakes to Avoid
- -Forgetting to convert percentage to decimal form
- -Using one vacancy rate instead of calculating the mean when multiple rates are given
- -Subtracting the vacancy amount instead of multiplying by (1 - vacancy rate)
Concept Deep Dive
Analysis
This question tests the fundamental income approach concept of calculating Effective Gross Income (EGI) from Potential Gross Income (PGI) by accounting for vacancy and collection losses. The calculation requires determining an appropriate vacancy rate from market data and applying it to reduce the potential income to a realistic effective income figure. However, there appears to be an error in either the question setup or answer choices, as the mathematical calculation using the mean vacancy rate (8.67%) yields $219,192, which would round to option A ($219,200), not the stated correct answer C ($225,600). The explanation suggests using 6% vacancy to reach answer C, but this contradicts the question's instruction to use the mean vacancy rate.
Background Knowledge
Effective Gross Income is calculated by subtracting vacancy and collection losses from Potential Gross Income, representing the actual income a property can reasonably be expected to generate. When multiple vacancy rates are available from comparable properties, appraisers typically use statistical measures like mean, median, or mode to determine an appropriate vacancy rate for the subject property.
Real-World Application
Appraisers regularly analyze vacancy rates from comparable properties to estimate realistic income projections for subject properties, as this directly impacts property value in the income approach and helps investors understand cash flow expectations.
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