What Is Effective Gross Income?
Let me explain Effective Gross Income, or EGI, directly to you. It's the Potential Gross Rental Income plus other income minus vacancy and credit costs for a rental property.
You calculate EGI by taking the potential gross income from your investment property, adding other forms of income it generates, and subtracting vacancy and collection losses.
Understanding Effective Gross Income (EGI)
EGI is a key variable you need to determine the value of a rental property and the true positive cash flow it could generate. Rental cash flow isn't a simple calculation; it includes all forms of income from the property minus the realistic costs involved with rental income. If you look at the variables in the EGI formula, you'll see how rental income plays out in the real world.
Key Takeaways
- Effective gross income is calculated by adding the potential gross rental income with other income and subtracting vacancy and credit costs of a rental property.
- EGI is key in determining the value of a rental property and the true positive cash flow it can produce.
- Gross potential rental income is the hypothetical amount an investor would receive not considering the negative situations associated with rental properties.
- Some of the most common examples of other income generated from rental properties include storage units, pet fees, monthly parking permits, and on-premise vending machines.
EGI Formula Explained
Now, let's break down the EGI formula. Start with Gross Potential Rental Income: This is the hypothetical amount you'd receive without any real-world rental headwinds. It assumes your property is rented every day of the year and renters pay the agreed rent in the lease. For instance, if rent is $2,000 a month, the gross potential is $24,000 annually.
Other Income Generated by the Rental Property
Next, consider other income from the property. This includes cash flow not directly from rent payments. Common sources are on-premise coin-operated laundry machines, vending machines, monthly parking permits, storage units, pet fees, and late fees.
Vacancy Costs
In reality, a unit won't always be rented all year. Vacancy costs cover periods between tenants when you're not getting rent due to the vacancy. You forecast these based on how long you think the unit will be empty, drawing from your experience or industry data if you've managed properties before.
Credit Costs
Credit costs happen when a unit is occupied but you don't receive the full agreed rent. The renter hasn't paid or hasn't paid in full. Like vacancy costs, this is an estimate based on historical data.
Why EGI Is Important
EGI matters to you as a real estate investor because you need to know if the property generates enough positive cash flow to cover monthly operating expenses, plus any liens or encumbrances from purchasing it.
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