The direct answer
The income approach must translate potential rent into collectible operating income. Vacancy reflects unoccupied space; collection loss reflects amounts not received from occupied or billed space. Both can reduce effective gross income, but analysts should avoid double counting when actual collections already reflect those losses.
Start from potential gross income
Build the income schedule from market- or contract-rent assumptions appropriate to the value premise. Identify concessions and other revenue adjustments separately.
To apply the approach to an editable scenario, use the Commercial Property Valuation Calculator. For the neighboring question, explore NOI Calculator.
Apply vacancy and collection loss on a consistent base
Use evidence from property history and comparable market operations when available. A physical occupancy percentage alone cannot fully describe collection performance.
Flow the adjusted revenue into NOI
After vacancy and collection allowances, add appropriate other income and subtract operating expenses to calculate NOI. Keep financing outside NOI.
Worked example
A property with $500,000 potential rent and a 6% combined vacancy and credit-loss assumption has $470,000 before other income. If operating expenses are $190,000 and no other income is assumed, modeled NOI is $280,000.
Open Commercial Property Valuation Calculator and test your assumptions →
Common mistakes and limitations
Do not subtract a blanket 6% allowance from already net collected revenue without checking whether vacancy and nonpayment were counted earlier.
Direct-capitalization estimate only. Cap rate selection and stabilized NOI require market judgment; not an appraisal.
Frequently asked questions
Are vacant units and unpaid tenant rent identical losses?
No. They arise from different operating conditions and can require different assumptions.
Can physical occupancy exceed economic occupancy?
Yes. Concessions and collection loss can reduce economic income despite high physical occupancy.
Sources and further reading
The article’s examples are illustrative arithmetic. The references below provide context for operating, valuation or transaction concepts; they do not endorse the assumptions or the calculator.
- Office of the Comptroller of the Currency — Comptroller's Handbook — Commercial Real Estate LendingNOI, direct capitalization, cap-rate valuation and DCF concepts for commercial real estate.
- Appraisal Institute — Basic Formulas — Income CapitalizationIncome/cap-rate/value relationships, gross income multiplier and debt-coverage formula references.
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