Effective Gross Income
Effective gross income (EGI) is the total income a property generates after subtracting vacancy and credit losses from potential gross income. It represents the realistic collectible income before operating expenses.
EGI is a critical step in the income approach to property valuation. It starts with potential gross income (PGI), which represents the total income a property would generate if every unit were leased at market rents with no collection losses. From PGI, you subtract vacancy losses (income lost from unoccupied units) and credit losses (income lost from tenants who fail to pay) to arrive at EGI. Then you add any other income sources such as parking fees, laundry revenue, storage rentals, or late fees.
The distinction between PGI and EGI is important because it forces investors to be realistic about income projections. A property may have a potential gross income of $500,000, but if the market has 10% vacancy and 2% credit loss, the effective gross income is only $440,000. Using PGI instead of EGI would lead to inflated NOI calculations and overpayment.
When analyzing a deal, compare the seller's reported vacancy and credit loss assumptions against market data and the property's historical performance. Some offering memorandums use unrealistically low vacancy assumptions to inflate projected returns. A careful investor will apply their own vacancy and credit loss factors based on comparable properties, the property's historical occupancy, and current market conditions.
Formula
Worked Example
A 20-unit apartment complex has potential gross income of $360,000 (all units at market rent). Market vacancy is 7% ($25,200) and credit loss is estimated at 2% ($7,200). Other income from laundry and parking is $12,000. EGI = $360,000 - $25,200 - $7,200 + $12,000 = $339,600.
Related Terms
Net Operating Income
Net operating income (NOI) is a property's total gross income minus all operating expenses, excluding debt service, capital expenditures, depreciation, and income taxes. It is the foundational metric used to determine a commercial property's value.
Vacancy Rate
The vacancy rate is the percentage of all available rental units or leasable square footage in a property or market that is unoccupied at a given point in time. It is a key indicator of market health and directly impacts a property's effective gross income.
Rent Roll
A rent roll is a detailed document listing every tenant in a property along with their unit number, lease start and end dates, current rent, security deposit, and other lease terms. It is the primary source of truth for verifying a property's income during due diligence.
Pro Forma
A pro forma is a forward-looking financial projection for a commercial property, modeling expected revenues, expenses, capital costs, debt service, and returns over a projected hold period. It is the central tool for investment decision-making.
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