What Is Effective Gross Income (All You Need To Know)

What is Effective Gross Income?

What is the effective gross income formula?

What are the essential elements you should know!

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What Is Effective Gross Income

The effective gross income is a financial phrase used to refer to the potential cash flow a rental property can produce.

To calculate the effective gross income, you’ll need to find the total gross rental income of a property (this is a hypothetical figure) by adding all possible sources of revenues and subtracting vacancies and credit costs.

For example, you may invest in a rental property that generates the following types of income (or has the potential to generate such income):

• Standard rental revenue 
• Storage fees
• Parking fees 
• Vending machine revenues 
• Laundry machine fees
• Pet fees
• Late fees 

When you take into account all the possible sources of revenues a rental property may offer, you can find its gross rental income potential.

Once the gross rental income potential is established, you can then deduct vacancy and credit costs to calculate EGI.

Effective Gross Income Definition

According to Investopedia, effective gross income is defined as follows:

As you can see, you can summarize the EGI definition as follows:

• It’s a gross income potential
• Related to rental income
• Less vacancy and credit costs 

Having a good understanding of what effective gross income means is important if you are looking to determine a property’s value and see how much income you can generate and the possible impact of vacancies, payment issues, or bad debt on your cash flow.

Rental Property Income

What are the possible revenue streams you may get from a rental revenue property?

Naturally, the first type of income stream you would expect from a rental property is rental revenue.

If you have a commercial real estate property, residential one, an industrial one, or any other piece of real estate property that you can rent to someone, you can generate rental revenues.

However, you can also generate other income from your rental property.

Here is a list of other income you may be able to generate by investing in a real estate rental property:

• Storage rental fees
• Parking permit fees 
• Vending machine revenues 
• Coin-operated laundy machine 
• Furniture rentals 
• Late payment penalties 
• Common area usage fees 
• Event hosting 
• Pet keeping services
• Advertising spaces 

This is a non-exhaustive list but you get the point.

Now, if you want to assess a rental property’s true revenue potential, you should calculate its rental revenues but also consider all the other types of income it can generate.

By calculating revenues from all sources, you are essentially calculating the potential gross income of the property.

Vacancies

In real estate, vancy refers to the possibility of your rental unit not being rented for a period of time (the unit is “vacant”).

In real life, although you would like your rental units to be rented all the time but you will have tenant movement from time to time where one tenant leaves and another one comes in.

When that happens, you may have your rental unit vacant allowing for the transition of the existing tenant and the entry of the new one.

As a real estate investor, you will need to consider the consequence of the vacancies on the annual cash flows expected to be generated by the property.

You can estimate vacancies based on the property’s historical records, you can look at comparable properties, or you can look at market averages.

What’s important is that you do factor in a certain amount of vacancies to offset the total revenues expected by a rental property.

Credit Loss

Credit loss is the possibility for a real estate property owner not to receive the expected rental revenue from his or her tenants as per the lease agreements in place.

In other words, the unit is rented but the rental income is not received for various reasons.

In some cases, some tenants are delinquent payers, some have held back rent to claim something in return, others have lost their job and can no longer afford to pay, and so on.

Also, depending on the local laws, when someone does not pay, you cannot evict them right away so you’ll be absorbing the credit loss.

Taking into account bad debt is crucial in evaluating a property’s cash flow and revenue potential.

Effective Gross Income Formula

What is the effective gross income formula?

To calculate the effective gross income, you must use the following formula:

• EGI = Effective Gross Income
• GPRI = Gross Potential Rental Income

The GPRI is a hypothetical number that you (or a real estate investor) will calculate to represent the total potential revenues the rental property can generate without considering any costs or expenses.

To calculate the gross potential income of a rental property, you must assume that the property will generate the income every day of the year or as contractually agreed with the tenants.

In other words, you need to assume that the rental property will perfectly generate all the income that it was expected to generate.

For example, if your property was rented for $5,000 per month, you must assume that the tenant will pay rent every month for the entire year giving you a gross potential rental income of $60,000.

From the GPRI, you must deduct vacancy costs.

Vacancies are costs that you incur for having your rental property unoccupied or not rented for a period of time (something very normal in real life).

When a tenant leaves and another one is expected, there may be a period of time where the property is not rented, that’s a vacancy cost.

Finally, credit costs are costs that are incurred when the rental property is effectively rented but the tenant does not pay in accordance with the agreement, has only partially paid, or does not pay on time.

How To Calculate Effective Gross Income

How do you calculate EGI?

To calculate the effective gross income, you’ll need to first calculate the total income potential (gross) of a property and then deduct any possible negative situations that can affect cash flow like vacancies and credit costs.

Let’s take an example to better illustrate the notion.

Imagine you are looking at a real estate property that offers you the potential to earn rental income from residential units, parking fees for renting out parking spaces, and laundry machine fees.

Imagine that you have 12 units that are rented for $1,000 per unit, you have 12 parking spaces rented for $100 per unit, and your laundry machines give you $500 per month.

This means that the Gross Potential Rental Income is ($12,000 X 12) + ($100 X 12) + ($500) = $13,700 per month.

This means that if everything goes perfectly, everyone pays on time, you can earn $13,700 per month resulting in a yearly potential of $164,400.

Now, imagine that every year, you have about 3 tenants that leave and it takes about two months for you to rent the apartment.

This means that you will have 6 months of vacancies to consider.

Luckily, all your tenants pay in full and on time, so you have no credit costs.

In this case, to calculate EGI, you’ll need to deduct the vacancy costs.

So, you’ll take your yearly potential of $164,400 and deduct $6,600 representing six months of rental loss and six months of parking rental loss.

Your EGI is therefore $157,800 (which means that your real estate property is generating very close to its maximum potential and so it’s a good investment but does not offer you more room to generate more income as it currently stands).

Effective Gross Income Multiplier

The effective gross income multiplier formula is as follows:

• EGIM = Effective Gross Income Multiplier
• EGI = Effective Gross Income

To calculate EGI, you must use the following formula:

What Is EGI Takeaways 

So what is the meaning of Effective Gross Income?

What does EGI stand for?

EGI stands for Effective Gross Income and it’s a financial calculation performed by investors looking to buy a real estate property.

Calculating effective gross income is important for investors as they can have a better appreciation of the potential cash flow of a property and the total potential it may generate.

Let’s look at a summary of our findings.

Effective Gross Income (EGI)

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