How is the effective gross income determined in the income approach to property valuation?

The effective gross income is determined by taking the annual potential gross income and deducting a vacancy allowance. This process reflects a more accurate estimate of the income that a property can generate because it accounts for the fact that not all units may be rented at all times and that there will be periods of vacancy.

In practical terms, potential gross income refers to the total income the property would generate if fully occupied and all rental rates were met. However, this figure does not account for vacancies, which can significantly impact a property's real income. By subtracting the estimated vacancy allowance, the effective gross income provides a realistic figure that property owners can expect to receive, thus forming a critical component in the income approach to property valuation.

The other options do not accurately describe the process for determining effective gross income. For instance, adding potential gross income to expenses does not reflect actual revenue; calculating average monthly income over multiple years does not take into account current occupancy levels; and subtracting property management fees would pertain to net income rather than the initial calculation of effective gross income. Each of these alternatives overlooks the crucial consideration of vacancies that directly affects the income-generating potential of a property.