EGI: Effective Gross Income
What is effective gross income and how do you calculate it?
Effective gross income (EGI) is an efficient way to estimate a property’s value and cash flow. It can be defined as a property’s gross potential rent plus other income (vending machines, laundry machines, late fees etc.) minus vacancies, credit loss, and loss to lease. Below we’ll break down the elements of effective gross income and look at how it’s used in commercial real estate.
Effective Gross Income Formula
EGI = Gross Potential Rent + Other Income - Vacancies - Credit Loss - Loss to Lease
Gross Potential Rent: Gross Potential Rent (GPR) is the maximum amount of rental income a property could generate at market rate, given it has 100% occupancy. For example, if an apartment building had 10 units, each with a market rent of $2,000/month, the building would have a monthly GPR of $20,000, and an annual GPR of $240,000.
Other Income: This typically includes vending machines, laundry machines, parking fees, storage, pet fees, and late fees for multifamily properties. It is more likely to include only vending machine income, parking spot rental, and late fees for other commercial property types such as retail or office.
Vacancies: Buildings are not fully occupied at all times and as such it’s essential to calculate for vacancy in the EGI formula. As a general rule, five to eight percent vacancy is considered average for commercial or multifamily properties, while it’s typically greater for specialized commercial property types such as hospitality or self-storage.
Credit loss: Credit loss occurs when a tenant is occupying a property, or a unit in a property, but is either not paying rent or not paying fully. Unfortunately for landlords, it can sometimes take 60-90 days (or even more) to legally evict someone from a property.
Loss to lease: Some EGI calculations include loss to lease, which refers to the income a landlord loses when they offer financial incentives for a tenant to sign a lease. This often comes in the form of free rent or as a small monthly rental discount over the term of the lease.
Effective Gross Income Calculations
In general, effective gross income can be calculated in one of two ways. A simple EGI calculation would involve taking potential rental income, adding other income, and subtracting vacancy. In contrast, a complex EGI calculation would involve also subtracting loss to lease and credit loss. Both methods are are a great way for investors to determine whether a property can be profitable.
If we use the numbers from the example earlier in this article, assuming the vacancy was 5%, and that the property generated $500 a month in other income ($6,000/year), we could do a simple EGI calculation like this:
$240,000 + $6,000 - $12,000 = $234,000
Using a more detailed calculation, we might factor in a credit loss of 2.5% of rent ($6,000) and a loss to lease of $10,000 (if the owner gave 5 tenants one month of free rent). This EGI calculation would look different:
$240,000 + $6,000 - $12,000 - $6,000 - $10,000 = $218,000
Simple vs Detailed EGI
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