Unlocking the Secrets of Effective Gross Income (EGI) for Real Estate Investment
Effective gross income (EGI) is the total income derived from a rental property, factoring in the potential gross rental income plus other income sources, minus vacancy and credit losses.
To calculate EGI, you begin with the potential gross income from an investment property, add other forms of income generated by that property, and subtract vacancy and collections losses.
Understanding Effective Gross Income (EGI)
EGI is crucial for assessing the true value and positive cash flow of a rental property, encompassing all income minus realistic costs associated with maintaining rental income. Deciphering EGI helps investors understand real-world rental income scenarios.
Key Takeaways
- Effective gross income is derived by adding potential gross rental income with other income and subtracting vacancy and credit costs of a rental property.
- EGI plays a crucial role in determining the value of a rental property and its true positive cash flow.
- Gross potential rental income represents the theoretical maximum income assuming no rental issues.
- Common additional income sources include storage units, pet fees, monthly parking permits, and on-premises vending machines.
EGI Formula Explained
Gross Potential Rental Income
Gross potential rental income is the theoretical maximum an investor would gain, assuming full occupancy and tenants paying the lease amount in full. For instance, if the agreed rent is $2,000 per month, the gross potential rental income is $24,000 annually.
Other Income Generated by the Rental Property
“Other” income sources from rental properties include a variety of additional revenue streams such as:
- On-premise coin-operated laundry machines
- On-premise vending machines
- Monthly parking permits
- Storage Units
- Pet Fees
- Late Fees
Vacancy Costs
Realistically, units are not rented out all year, resulting in vacancy periods where no rental income is received. Vacancy costs reflect these gaps, estimated based on the owner’s experience or industry data.
Credit Costs
Credit costs occur when tenants fail to pay rent on time or in full. These costs are projected based on historical data, reflecting the inevitable payment gaps.
Why EGI Is Important
Understanding EGI is crucial for real estate investors to ensure a potential property generates enough positive cash flow to cover operating expenses, mortgages, and other financial liabilities, securing its profitability and sustainability.
Related Terms: Net Operating Income, Gross Operating Income, Capitalization Rate, Cash on Cash Return.
