Wealth Opportunities in Commercial Real Estate: Management, Financing, and Marketing of Investment Properties

Vacancy and Collection Loss: Gross Income Reducers

A vacancy factor reduces gross income by an amount, usually expressed as a percentage, in recognition of the fact that a project's occupancy is typically less than 100 percent over the long run. You must take a vacancy into consideration, even if occupancy is 100 percent at the time your analysis is being conducted.

You must also consider a collection loss amount. A collection loss amount recognizes that not all tenants honor their contractual lease obligations. In other words, despite the tenant's written obligation to pay rent, a certain percentage of the tenants will default, whether because of a failed business or some other reason.

Even if the project is 100 percent leased to a long-term credit tenant, investors and lenders will, for valuation and underwriting purposes, require that vacancy and collection loss factors be inserted into the analysis. A standard vacancy and collection loss figure is 5 percent of gross income, but this amount may vary depending on market conditions and on the actual leases in place. If a 5 percent factor is used in our hypothetical model, the vacancy and collection loss would be calculated as follows:

Gross Income × Vacancy and Collection Loss Factor =Vacancy and Collection Loss

$1,440,000 × 5% = $72,000

The vacancy and collection loss factor can be expressed in ratio form as follows:

The ...