The Income Approach is one of the most widely used methods for valuing real property. In fact, it is often considered to be the primary approach to value for commercial and multi-family residential property types. These types of properties are regularly purchased by investors, who are not particularly interested in the real estate but the income stream the real estate can generate. In this series of articles, we’ve looked at some tips for estimating market rent and accounting for rent concessions while deriving an Income Approach. This time I’d like to discuss adjusting for vacancy and collection loss as part of the Income Approach. When conducting an Income Approach, the first expense that any appraiser or investor should consider is vacancy and collection loss (V&C). Most properties experience some level of regular vacancies over the long term. And even if a property has a tenant committed to a long-term stable lease, there is still the risk that a tenant goes bankrupt or is unable to pay its rental obligations for whatever reason. Thus, even in the most stable situations, any Income Approach should include some allowance for vacancy and collection loss. Now that we understand a little better what the V&C expense is and why we need to account for it, next we need to try to quantify the proper allowance for the property being analyzed. Vacancies can vary drastically from property to property based on property type, regional demand, location, the competence of management, and a myriad of other factors. Perhaps the best place to start is with the occupancy history of the subject property itself. Let’s look at some common scenarios: Single-tenant properties, like a single family home or a large industrial distribution facility, may be fully leased for years at a time, experiencing no vacancy at all during this period. However, it may take many months to find a new tenant when the old one leaves. For example, consider a single-tenant industrial building that is leased for 36 months. After the lease expires and the tenant leaves, assume it takes four months to clean the property, market it, and get a new tenant in place. In this example, the property was vacant for four months over a 40-month stretch or 10% of the time on average. Single-tenant properties often experience vacancies in bursts like this. On the other hand, multi-tenant properties, like apartment complexes or retail centers, often experience individual tenant turnover on a regular basis. As tenants come and go, it is not uncommon to have a few units or suites vacant nearly all the time. For example, consider a 20-unit apartment complex. As renters come and go, the building is usually mostly occupied; however, if 4 of the 20 units are vacant at any given time on average, then the long-term vacancy rate for this property is probably around 20%. Another good source of vacancy information can be market surveys from commercial real estate brokerage. These surveys will often list average vacancy or occupancy rates organized by region and property type. For example, a typical market survey may show averaged vacancy rates for retail, office, industrial, and apartment sectors, in a specific region during a specific period. Similar to the information provided by commercial brokerage surveys, reports are available via online real estate databases, such as CoStar Property. These websites often have tools which you can use to generate vacancy reports using customizable parameters you select. You can narrow a search based on property type, location, size, and many other factors. These are the most common sources of vacancy information. A prudent appraiser or investor will use as much data as possible to estimate a reasonable long term vacancy allowance for a subject property.