In preparing a stabilized pro forma for an apartment building, an appraiser analyzes the property's 5-year history and market data. The appraiser concludes a long-term, typical vacancy and collection loss of 6% is supportable. To correctly develop the stabilized effective gross income estimate, the appraiser should apply this 6% rate to which of the following?
Correct Answer
C) The market-derived estimate of potential gross income at market rents.
In a stabilized pro forma for market valuation, vacancy and collection loss is applied to the market-derived estimate of Potential Gross Income (PGI) at current market rental rates, reflecting the property's earning capacity as if it were typically occupied. PGI is the total income the property would generate at 100% occupancy at market rates.
Why This Is the Correct Answer
Vacancy and collection loss is applied to potential gross income at market rents to reach effective gross income, since direct capitalization values the property's earning capacity at market.
Why the Other Options Are Wrong
Option A: The property's average historical gross income over the prior five years.
A historical average reproduces past conditions rather than projecting forward from the effective date.
Option B: The property's projected income based on current leases in place.
In-place lease income reflects contract rather than market rents, and is addressed through leasehold or leased fee analysis instead.
Option D: The net operating income before capital expenses are deducted.
Net operating income is already net of vacancy and expenses. Applying the loss factor again would deduct it twice.
Top of the Statement, at Market
Top of the Statement, at Market. Potential gross income is where the loss factor lands.
How to use: Build the statement in order. Applying a percentage further down always double-counts something.
Exam Tip
Contract rents above or below market are handled through leasehold and leased fee analysis rather than by substituting them into the stabilised pro forma.
Common Mistakes to Avoid
- -Applying the loss factor to net operating income
- -Using in-place contract rents in a stabilised pro forma
- -Substituting a historical average for a forward projection
Concept Deep Dive
Analysis
A stabilised pro forma projects what the property will typically produce, and the calculation begins at the top with potential gross income at market rents — what the property would generate fully leased at rents the market currently supports. The 6 percent vacancy and collection loss is applied to that figure to reach effective gross income, from which operating expenses are deducted to reach net operating income. Two points make this the right base. Market rents rather than in-place rents are used because direct capitalization values the property's earning capacity, and rates extracted from comparable sales reflect properties earning market rents; contract rents above or below market are handled as separate leasehold or leased fee considerations rather than by substituting them into the pro forma. And potential gross income rather than a historical average is used because the projection speaks to the future from the effective date, informed by history rather than reproducing it. Applying the rate to net operating income would deduct the loss twice over.
Background Knowledge
A stabilised pro forma begins with potential gross income at market rents, deducts vacancy and collection loss to give effective gross income, and deducts operating expenses to give net operating income.
Real-World Application
An appraiser computes potential gross income at market rents, applies a 6 percent stabilised loss factor, and deducts market-supported operating expenses to reach net operating income.
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:
The reversion in a discounted cash flow model represents:
Building A (new, credit tenant, 20-year lease) and Building B (older, month-to-month tenants) sell the same week. Their cap rates should differ how?
An overall rate extracted from a sale whose NOI excluded reserves, applied to a subject NOI that includes them, will:
Replacement reserves cover which kind of expenditure?
What is the primary distinction, for appraisal purposes, between 'vacancy loss' and 'collection loss'?
An appraiser is analyzing a mixed-use property with retail and office components. The retail segment has a potential gross income of $180,000 with a market vacancy of 8%. The office segment has a potential gross income of $120,000 with a market vacancy of 12%. What is the overall effective gross income for the property?
The mortgage constant represents:
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