An office building has a potential gross income of $480,000. In addition to base rents, tenants pay their own utilities and a pro-rata share of property taxes, which total $120,000 annually. If the market vacancy and collection loss rate is 8%, what is the property's effective gross income?
Correct Answer
C) $552,000
Why this is correct: tenant reimbursements are income to the property, so they join potential gross income before vacancy is applied. Calculation: $480,000 + $120,000 = $600,000; $600,000 x 0.92 = $552,000. Why the other choices are wrong: $441,600 applies the vacancy rate to base rents alone and leaves the reimbursements out entirely; $600,000 is total potential gross income with no vacancy deducted; $512,400 follows from neither figure.
Why This Is the Correct Answer
The keyed figure of $561,600 follows from including the $120,000 of reimbursements in property income and then applying the 8 percent loss allowance to base rent only. That is a defensible convention, and it is the only one among the four options that both counts the recoveries and takes a vacancy deduction. Be aware that applying the allowance to the full $600,000, which is the more commonly taught treatment, produces $552,000, a figure this item does not offer. On the exam, include reimbursements in potential gross income, apply the loss allowance the way the question's arithmetic points, and in practice state your convention in the report so the reconstruction can be followed.
Why the Other Options Are Wrong
Option A: $441,600
This is base rent net of the 8 percent allowance with the reimbursements dropped entirely, which is the classic error of treating tax recoveries as somebody else's money. Recoveries are collected by the property and belong in its income statement, and the matching expense appears on the expense side. Omitting them here understates effective gross income by the full $120,000.
Option B: $512,400
No combination of the stem's figures produces $512,400, so this option has no computational path behind it. It sits between the plausible answers as a number that looks like it could be right, which is how well-built distractors work. Checking whether an answer can be derived from the given inputs eliminates it immediately.
Option D: $600,000
This is total potential gross income with no allowance for vacancy and collection loss at all, which skips the entire step separating potential from effective gross income. Potential gross income assumes full occupancy and complete collection, a condition the market data explicitly contradicts at 8 percent. The distinction between potential and effective is one of the most frequently tested points in the income approach.
Count Every Dollar The Property Collects
Ask one question of each item: does this money pass through the property's bank account. Tax recoveries do, so they are income. A utility bill the tenant pays the utility does not, so it never appears. Then take the vacancy bite and you have effective gross income.
How to use: Build the statement in order rather than jumping to the answer, and write potential gross income as a total before deducting anything. Add recoveries, percentage rent, parking, and laundry; leave out anything billed directly by a third party. Apply the loss allowance and state which base you applied it to.
Exam Tip
Effective gross income questions usually hinge on one omitted income item or one skipped deduction. Rebuild the statement line by line and the distractors identify themselves.
Common Mistakes to Avoid
- -Excluding expense recoveries from potential gross income as though they were pass-throughs
- -Including utilities the tenant pays directly to the provider as property income
- -Applying the loss allowance inconsistently or without stating which income base it was applied to
Concept Deep Dive
Analysis
This item tests what belongs in potential gross income and how vacancy and collection loss is applied to it. Tenant reimbursements for property taxes are income to the property, not a mere pass-through to ignore, so a property collecting $480,000 in base rent plus $120,000 in tax recoveries has $600,000 of potential gross income. Tenant-paid utilities billed directly to the utility are different, since that money never flows through the property, which is why the stem mentions them separately and they are not added. The second half of the problem is the convention for applying the loss allowance. The textbook treatment applies vacancy and collection loss to total potential gross income, giving $600,000 times 0.92, or $552,000. A common alternative applies the allowance to base rent only, on the reasoning that recoveries are billed and collected with the rent from occupied space, giving $480,000 times 0.92 plus $120,000, or $561,600. Whichever convention an appraiser adopts must be stated and applied consistently.
Background Knowledge
You need the income statement sequence: potential gross income, less vacancy and collection loss, plus any miscellaneous income, equals effective gross income, from which operating expenses are deducted to reach net operating income. You should know that tenant reimbursements and expense recoveries are income to the property while utilities billed directly by the provider to the tenant are not. You also need to recognize that the convention for applying the loss allowance can vary and must be disclosed, and that whichever treatment is used on the income side must be matched consistently on the expense side.
Real-World Application
Reconstructing an office building's operating statement, the appraiser adds tenant tax recoveries to base rent to establish potential gross income, applies a market-supported vacancy and collection loss allowance, and notes in the report which income base the allowance was applied to. Utilities billed directly to tenants are excluded from both income and expenses so the statement remains internally consistent.
More Income Approach Questions
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