Real Estate Appraisal Practice Exam

What does the term 'effective gross income' refer to in the context of property appraisal?

1. The total rent collected from all tenants.

2. The total potential income adjusted for vacancy and credit losses.

3. The net operating income after all expenses.

4. The revenue generated before expenses are deducted.

The correct answer is: The total potential income adjusted for vacancy and credit losses.

The term 'effective gross income' is indeed best defined as the total potential income from a property adjusted for vacancy and credit losses. This measure takes into consideration the maximum income that the property could generate if it were fully occupied but then subtracts the expected losses due to unoccupied units (vacancies) or tenants not paying their rents (credit losses). By doing so, effective gross income provides a more accurate reflection of the realistic income a property can produce, which is critical for appraisers and investors to understand the potential cash flow. In property appraisal, knowing the effective gross income helps in evaluating the financial health of a property, guiding better investment and management decisions. This figure is essential before any operating expenses are accounted for, as it informs the next steps in calculating net operating income and potential cash flow. The other options either define a different aspect of income or do not accurately incorporate the adjustment for potential losses, making them less aligned with the accepted definition of effective gross income.