What is Effective Gross Income?
The Effective Gross Income (EGI) is defined as the total potential revenue generated by a real estate rental property investment, net of any vacancy and credit losses.
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How to Calculate Effective Gross Income (EGI)
The effective gross income (EGI) is the sum of a real estate property’s total potential income less any adjustments that pertain to vacancy and credit (collection) losses.
The effective gross income (EGI) metric – often used interchangeably with the term “effective gross revenue” (or EGR) – measures the approximate income that a property owner can earn on a rental property investment.
The EGI of a real estate property investment offers practical insights into whether enough positive cash flows can be brought in to cover its total operating expenses and be profitable.
The composition of the property’s total potential income is, for the most part, rental income.
- Rental Income → The rental income earned on an investment property, whereby the owner leases out the property in exchange for periodic rental payments from the tenant(s) for an agreed-upon time period, is the primary source of returns.
- Other Income → However, other sources of income generated by the property, such as application fees and payments collected from tenants for usage of amenities, late fees, pet fees, and on-premise services (e.g. vending machines, laundry, dry cleaning, extra storage units, parking permits) must also be included.
Once the gross potential income is determined, the next step is to deduct any incurred costs, such as vacancy costs and credit costs.
- Vacancy Costs → The vacancy costs are the projected losses that a property owner will incur because of vacant units. The vacancy rate assumption determines the estimated vacancy costs, which is the percentage of properties (or property units) not occupied by a tenant.
- Credit Costs → The credit costs, or “collection costs”, are the losses that stem from tenants not fulfilling their obligations to pay rent. Occasionally, a property owner might not be able to collect rental income from a tenant on time, but retrieve the unmet amount (and the late fee) on a later date. If not, the tenant might not have the financial capacity to meet the payment, resulting in a default on the lease and property foreclosure.
Effective Gross Income Formula (EGI)
The formula to calculate the effective gross income (EGI) is as follows:
Where:
- Potential Gross Income (PGI) = Total Rental Income + Other Income
