To understand a rental property’s true earning potential, you need to look beyond headline rents.
Effective Gross Income (EGI) tells you how much income the property actually generates after accounting for vacancy and credit loss, so it’s much more effective than gross scheduled rent if you want to assess actual performance and cash flow potential.
What to remember
- To quickly determine EGI, add up the property’s potential rental income and all other revenue sources (like parking or laundry), then deduct expected vacancy and credit losses.
- EGI gives you a clearer, more practical view of a CRE building’s income because it shows what the property actually earns, not just what it “could” earn in perfect conditions.
- EGI helps you test whether the property can support its expenses and financing. It also gives you a solid starting point when comparing deals or estimating value.
- Modern property management tools can track income and losses in real time to make it easier to calculate EGI accurately.
What is effective gross income (EGI) in commercial real estate?
EGI represents the total income a rental property can generate after accounting for vacancy and credit losses.
By factoring in both actual revenue streams and potential income reductions, you will have a clearer picture of a building’s true earning potential.
This makes EGI extremely useful in comparing deals and stress-testing your assumptions.
Some professionals also refer to this figure as effective gross revenue (EGR). Simply put, it reflects the income you can reasonably expect to bring in from a rental investment.
How do you calculate effective gross income in commercial real estate?
The formula for calculating EGI is straightforward:
Effective Gross Income (EGI) = Potential Gross Income (PGI) – Vacancy and Credit Losses
Where:
Potential Gross Income (PGI) = Total Rental Income + Other Income
EGI helps determine whether a property can generate enough cash flow to cover your operating expenses and still produce a profit.
What factors go into a commercial property’s potential gross income?
Potential gross income is the income your property would produce if every unit were occupied at market rates. It’s made up of rental and other income.
Rental income
This is the rent your tenants pay for using your property over an agreed time period.
Other income
This is the money you earn from other revenue streams, such as:
- Application fees
- Amenity charges
- Late fees
- Pet fees
Payments for on-site services can also generate income.
These include:
- Laundry machines
- Vending machines
- Parking permits
- Extra storage units
- Concierge-style services.
How do you adjust for vacancy costs and credit losses in commercial real estate?
Now that you have your property’s gross potential income, subtract an estimated percentage for vacancy (units that sit empty) and credit loss (unpaid rent from delinquent tenants).
Vacancy costs
In reality, some of your units will not always be rented for the whole year. Vacancy costs represent the anticipated loss from those units that remain unoccupied.
These are based on a projected vacancy rate, which is essentially the percentage of units you expect to not have tenants during the analysis period.
If you have had a little experience in rental property management, you can estimate this figure based on the historical occupancy patterns. You can also refer to industry benchmarks or broader market data to make an informed assumption.
Credit losses
Credit losses refer to the rent you expected to collect but didn’t, usually because tenants paid late or stopped paying altogether.
In some cases, you may be able to collect the overdue amount later along with late fees. In other cases, the tenant may default, leading to permanent income loss and even potential legal or foreclosure issues.
By deducting these estimated losses, you can determine the property’s actual expected income.
Similar to vacancy costs, these losses are typically estimated using past collection trends or historical performance data for the property.
Having strong screening procedures and automated payment systems can help reduce the frequency and severity of these losses.
What’s the difference between NOI and EGI in commercial real estate?
EGI and Net Operating Income (NOI) measure different stages of a property’s cash flow.
EGI is the income a property actually brings in after subtracting vacancy and credit losses from its potential gross income. It includes base rent plus other revenue streams like parking or laundry.
NOI goes a step further because it subtracts operating expenses — things like maintenance, insurance, and property management — from the EGI.
That’s why:
NOI = EGI – Operating Expenses
In short, EGI shows how much income comes in, while NOI shows how much is left after running the property.
Sample EGI calculations for CRE underwriting
Let’s walk through a sample calculation so you can estimate the effective gross income of an existing rental property.
Let’s imagine that your property contains 100 units, and each unit rents for $4,000 per month:
Total number of units: 100
Monthly rent per unit: $4,000
You can determine your monthly gross potential rental income by multiplying the unit count by the monthly rent:
100 x $4,000 = $400,000
CRE financial analyses usually rely on annual figures, so multiply that number by 12 to get the annual gross potential rental income:
$400,000 × 12 = $4,800,000
Next, include the property’s other income sources.
For this example, let’s imagine that the property generates $200,000 per year from additional revenue streams such as parking fees, storage units, or amenity charges.
Other income: $200,000
Add up the annual rental income and other income to find the potential gross income (PGI) — the amount the property could earn if fully occupied with no collection issues:
PGI = $4,800,000 + $200,000 = $5,000,000
Now that you have your PGI, you can calculate the EGI.
Let’s say that based on historical trends and current market research, you are expecting $800,000 in combined vacancy and credit losses.
Vacancy and credit losses: $800,000
Subtract these losses from the PGI to determine the property’s pro forma EGI.
EGI = $5,000,000 – $800,000 = $4,200,000
So, in this scenario, $4.2 million is the realistic income you can expect the property to generate.
Another example of an EGI calculation
Now let’s imagine a commercial property with 12 units. You’re renting each out for $5,000 per month. This results in:
Monthly GPI: 12 × $5,000 = $60,000
Annual GPI: $60,000 × 12 = $720,000
The property also earns $7,000 a year from additional income sources such as laundry machines, storage rentals, pet fees, and vending machines.
Using past performance and your knowledge of the local rental market, you estimate $50,000 in combined vacancy and credit losses for the year.
The EGI calculation would look like this:
- EGI = $720,000 + $7,000 – $50,000
- EGI = $677,000
This means that the 12-unit property is expected to generate an effective gross income of $677,000 for the year.
Is it possible to improve EGI in commercial real estate?
Yes. If you’re not satisfied with the current EGI, there are things you can do to enhance it:
- Optimize rental rates using market insights. Regularly review comparable properties and local demand to ensure that rents stay competitive.
- Use targeted marketing to reduce vacancies. Strong advertising and quick response times, combined with well-managed listings, can shorten vacancy periods.
- Expand the property’s income sources. Adding services such as paid parking or amenity-based fees can boost your non-rental income.
- Strengthen your screening and retention efforts. You can reduce credit losses and improve renewals by carefully choosing tenants and communicating with them consistently.
- Automate maintenance and tenant support. Use digital tools that can help you track repairs and manage requests, so you can improve tenant satisfaction and reduce unexpected turnover.
Why is it important to accurately calculate EGI in commercial real estate?
If you misunderstand or overlook EGI, your income projections will be off — and that can skew everything from pricing to loan sizing.
And since EGI feeds directly into NOI, any misstep early in the process can carry through the rest of your analysis.
Let’s make up an example showing how mistakes in EGI calculations can throw off your entire investment model.
Let’s imagine that you’re looking at a small CRE property with a gross potential income of $200,000.
You assume full occupancy and no rent loss, so you treat that full $200,000 as your EGI. But in reality, the building averages 8% vacancy and 2% credit loss annually, so the actual EGI is closer to $180,000.
Let’s say that the property’s operating expenses total $70,000.
If you base your NOI on the inflated EGI, you’ll project $130,000 in income ($200,000 – $70,000). But the real NOI is only $110,000. At a 6% cap rate, that’s a $333,000 difference in value:
$130,000 ÷ 0.06 = $2.17 million
$110,000 ÷ 0.06 = $1.83 million
That $333K overvaluation could cause you to overpay and/or take on more debt than the property can comfortably support.
Get CRE financing and industry guidance
Private Capital Investors is a trusted partner for CRE investors. In addition to offering direct lending options, our team can guide you through the process and help you make informed decisions about your commercial real estate investments.
Call us at 972-865-6206 to discuss your loan needs.
Additional sources:
- https://www.re-leased.com/terms/effective-gross-income-egi#:~:text=What%20Is%20Effective%20Gross%20Income,Potential%20Rental%20Income
- https://fnrpusa.com/blog/effective-gross-income-real-estate/?utm_term=blog%2Beffective-gross-income-real-estate
- https://www.investopedia.com/terms/e/effective-gross-income-egi.asp
- https://www.multifamily.loans/apartment-finance-blog/what-is-effective-gross-income/
