When looking at rental properties as potential investments, it is important to focus not only on the obvious factors such as the asset’s location and class, but the numbers behind the property as well — and we’re not simply talking property values. Multifamily investors and lenders alike rely on many different metrics in order to get a clearer picture of the financial strengths of a rental property. One metric that is of particular interest concerning the value of an investment property is effective gross income, or EGI.

Effective gross income measures the potential total revenue of an asset. More specifically, effective gross income is defined as the sum of an asset’s collected rent and other income sources, less vacancy costs and credit losses. EGI is an important factor in determining a property’s value, as it best represents the asset’s true positive cash flow.

Calculating Effective Gross Income

In order to determine effective gross income, the property’s gross potential income, or GPI — sometimes called gross potential rental income (GPRI) — must be calculated first. With that value in hand, any additional income generated by the property must be factored into the equation as well. This typically includes income from vending machines, paid parking spaces, storage units, pet fees, or other similar sources.

The next metrics to be determined are the vacancy and credit costs. Unlike with GPRI, which assumes zero vacancies and all rents paid in full each month, effective gross income accounts for the more realistic issues of vacancies and credit disruptions that most property owners find unavoidable. Even so, these metrics are hypothetical estimations based on historical data — after all, no one can actually predict the future. In most cases, these figures are determined utilizing any available industry, market, and historical data of relevance.

Once you have determined all of the aforementioned figures, the EGI formula is straightforward. Effective gross income is typically representative of annual revenues, so all of its components should be calculated on an annual basis as well.

The Effective Gross Income Formula

EGI = Rental GPI + Other income - Vacancy and credit costs

An Example of an EGI Calculation

Need an example to bring the math to life? Imagine a property with 12 units. Each unit has a market rent of $5,000 per month. That’s equivalent to a monthly GPI of $60,000, or an annual GPI of $720,000. Additionally, the property has on-site laundry machines, rentable storage spaces, pet fees, and vending machines which generate $7,000 in total. Finally, based on some historical data of the property and your personal knowledge of the rental market in your area, you can safely assume vacancy and credit costs of roughly $50,000 per year. Thus, the calculation would be:

EGI = $720,000 + $7,000 - $50,000

EGI = $677,000

And there you have it. The 12-unit community’s effective gross income is $677,000.

Components Used to Calculate EGI

For further clarification, we will break down the different components of the EGI formula.

Gross Potential Income

Gross potential income, or GPI, is a calculation of the maximum amount of rental income that a landlord could generate from a property. GPI assumes that a property has 0% vacancy and that all rents are paid in full all year.

Other Sources of Income

This component of includes all non-rental income generated by the property. After all, It isn’t uncommon for property owners to have multiple revenue streams from one asset. Though the list is not exhaustive, some common items to include here are:

• Parking fees

• Storage unit fees

• Vending machine income

• Laundry machine income

• Pet fees

• Clubhouse rentals

• Late fees

Vacancy and Credit Losses

Easily the most complicated part of the formula, it’s essential to your EGI calculation to try to accurately forecast costs associated with vacancies or credit losses. What makes the EGI metric so valuable to investors is that unlike other similar metrics, EGI assumes that a property rarely sustains full occupancy over a one-year period and, similarly, that rent payments may not always be paid in full or on time — despite the terms of the lease.

That said, experienced commercial real estate investors can usually draw upon past knowledge of similar assets to estimate these costs. Even sans-experience, adequate estimations can be formed through the study of current and historical market reports or industry data relevant to the property and area.

The Importance of EGI

Effective gross income is an essential calculation for an investor because it is used to forecast an asset’s positive cash flow. Generally speaking, it is important to know whether or not the property you are considering purchasing can generate enough positive cash flow to cover its operating expenses and turn a profit. EGI may not be the only metric used for this purpose, but it is definitely unique in its inclusion of potential losses caused by vacancies or partial payments. For this reason — despite the fact that it is more or less an estimation — many investors find it to be incredibly useful when comparing between potential investments.