Effective Gross Income CalculationThe formula for the Effective Gross Income (EGI): EGI = Potential Gross Rental Income + Other Income – Vacancy & Bad Debt Allowance Note that the Potential Gross Income (PGI) includes primarily rental income, but it accounts also for any other income that may be produced by the property, such as income from vending machines, laundry room, parking, etc. The vacancy and bad debt allowance accounts for space/units that remain vacant during the year and, as such, do not actually provide any rental income to the landlord, while bad debt allowances cover any rent that is owed during the year but is not paid by the tenants. Example: Therefore, Effective Gross Income = 150,000 + 5,000 – 15,000 = 140,000 Thus, in this example, the annual EGI that the property can produce at the time of the purchase is equal to $140,000.
Second, the EGI reflects the gross income that the property can produce at the time of the purchase and not necessarily the income that the property will producing in the future and over the holding period. For example if the property is a multi-tenant property with leases expiring next year and the market rents are falling, then the property’s EGI after a year from its acquisition maybe considerably lower. Investors aiming for double-digit returns need to carefully assess the most likely cash flows that the property will produce over the holding period through the discounted cash flow model. In this analysis the local market needs to be carefully analyzed in order to determine the most likely changes in rents and value of the property considered for acquisition. Investors aiming for double-digit returns need to target properties with very strong prospects for increasing EGI and NOI, as well increasing property value, over the holding period of the property.
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