EGI is the effective income calculated by subtracting any losses due to vacancy, lease concessions, employees, model units, and bad debt.
Effective gross income is the effective income generated by a property after deducting all the expenses and losses. The effective income includes rent, laundry machines, parking fees, vending machines etc. The deductions include vacancy, credit cost and loss to lease.
When assessing a property, it is important for a real estate investor to factor in all the sources of income that can be generated from the property and also the losses so as to determine the value of the rental property. It also helps to fix up an ideal rental amount that ensures he is not getting paid less than the market rent.
The formula for calculating the effective gross income of a property is subtracting the potential rental income and other income from all the expenses that can be incurred. Hence, the formula is:
Effective Gross Income (EGI) = Gross Potential Rent + Other Income - Vacancies - Credit loss - Loss to Lease
Here, gross potential rent means estimating the maximum amount of rent that can be generated if the property is 100% occupied and the rent amount is the same as the market rent. Other income includes the income generated from parking lot fee, vending machines etc.
For deductions, the percentage of vacancy currently in the market for a similar property is taken into consideration. It also includes credit loss, meaning a tenant is occupying the property but isn’t paying the rent or only paying a part of the rent. Then, loss to lease is also deducted which means that the owner is charging less than the market rent.
All of these details must be properly calculated and then the effective gross income must be determined before an investor decides to invest.
As for any investment, the investor needs to know if the property they are going to invest in will be generating a positive cash flow or a negative cash flow. To determine this, they need to calculate the effective gross income of the property, meaning that the income is enough to manage monthly expenses of the property and pay off any loans taken to purchase the property.
The bottom line is that effective gross income will determine if the investment is going to be successful or not in the future.
To understand how to calculate effective gross income, let’s take an example. Suppose an investor wants to invest in an apartment building which has 10 units. The market rent is $1000 for a month so GPR for a month will be $10,000 and for a year it will be $1,20,000. Now, let’s say the other income amount is $4000 a month, meaning $48,000 in a year. Also, the vacancy rate is 5%. How will the investor calculate the EGI?
Here, EGI = 1,20,000 + 48,000 - 6000 = 1,62,000
Hence, the EGI for this case is $1,62,000. Here, investors often include credit loss or loss to lease amounts as well. The more details the investor has, the more accurate the EGI will be.
While effective gross income considers the potential gross rental income and other income and subtracts them from vacancy rate and such factors, net operating income is much different. In NOI, the expenses made on the property such as repair and maintenance, property taxes etc. is subtracted from the total revenue the property makes through rent and other income.
In other words, we can say that NOI is EGI minus the operating expenses.
The effective gross income helps an investor to determine how much he can make through the rent amount he sets and through the amenities he provides to his tenants. Additionally, he can also determine what his losses will be and whether the loss will be higher or lower than the income. To do this, the investor must conduct a thorough market analysis and gather information on the vacancy rate, credit loss, market rent, economic conditions, etc.