Effective Gross Income (EGI) is the potential gross income generated by a rental property plus other incomes and less forecasted or existing vacancies and credit costs. Rental revenue earned from a rental property is not the only variable that should be considered when assessing the value of a rented property; profits obtained from other services on the premises should also be considered and recognized on financial statements. Moreover, rental units may trigger a loss via vacancies, legal costs, or renovations.
Effective Gross Income (EGI) is the potential gross income that can be generated by a rental property plus other incomes and less forecasted or existing vacancies and credit costs.
EGI is critical when determining a property’s value as it provides insight on how much revenue the property will potentially generate after rentals, vacancies, and payment issues that may arise are factored in.
Effective Gross Income can be calculated as Potential Gross Rental Income + Other Income – Allowances for Vacancy and Bad Debts
Formula for Effective Gross Income
Effective Gross Income can be calculated as follows:
EGI = Potential Gross Rental Income + Other Income – Allowances for Vacancies and Bad Debts
How to Compute Effective Gross Income
To calculate effective gross income, it is important to obtain all the relevant information pertaining to all the revenue generation avenues of a rental property. The first step in computing the EGI is to calculate the potential gross income. The potential rental income is the potential gross income.
The next step would be to sum up the other incomes that are received from the property. The incomes can come from parking fees, vending machines, etc. They are added to the potential gross income.
After summing up all the income generated or to be generated by the property, the next step is to account for allowances of bad debts and vacancies. They are deducted from the total income generated. A vacancy allowance is used to refer to income lost due to an unoccupied unit. A bad debt allowance is an allowance for tenants who may fail to may payments, despite occupying the unit.
After deducting all the allowances, the computation for the EGI is complete.
Sample EGI Calculation
A rental property charges a monthly rent of $1,500. The property operates laundry machines, parking bays, and vending machines, each generating $3,500, $4,000, and $3,000, respectively, for the year. Assuming that the property was not occupied for two months out of the year, the EGI computation would be;
Potential Gross Income: $1,500 x 12 months = $18,000
Other Income: $3,500 + $4,000 + $3,000 = $10,500
Allowances for Bad Debts and Vacancies: $1,500 x 2 months = $3,000
Hence, the EGI would be ($18,000 + $10,500) – $3,000 = $25,500
The image below shows another example of an EGI calculation:
Examples of Other Income for a Rental Property
It is common for many property owners to have more revenue streams other than rental fees. Examples of “Other Income” can include (but may not be limited to) fees for additional storage units, vending machines, coin-operated laundry machines that are on the premises or regular laundry service, furniture rentals, parking fees or permits, penalties for late payments, fees for using common areas for parties or event hosting, and for some properties, fees for keeping a pet.
Understanding the Importance of EGI
Effective gross income is critical when determining a property’s value as it provides insight on how much revenue the property will potentially generate after rentals, vacancies, and payment issues that may arise are factored in. For many real estate investors, it is common practice to use a property’s net operating income (NOI) and cap rate in order to estimate a bid price.
The bid price is calculated by dividing the NOI by the cap rate. In order to calculate the net operating income, the EGI must first be computed, as it forms the revenue portion of the NOI computation. It is why it is key to undertake a precise EGI computation when considering a potential property for purchase.
CFI offers the Commercial Banking & Credit Analyst (CBCA)™ certification program for those looking to take their careers to the next level. To keep learning and developing your knowledge base, please explore the additional relevant resources below:
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