CHAPTER 14

Calculation 8: Gross Operating Income (Effective Gross Income)

What It Means

The gross operating income (GOI) (also called effective gross income, or EGI) equals the property’s annual gross scheduled income less vacancy and credit loss. GOI is not the property’s potential income, but represents instead the actual income that you expect to collect.

If you’ve read the previous two chapters about gross scheduled income and vacancy and credit loss, then you should implicitly understand GOI; it is simply the difference between those two amounts. We won’t belabor the term here but will just provide a quick review of the calculation. If you haven’t done so already, you should read the previous two chapters.

How to Calculate

Gross Operating Income = Gross Scheduled Income less Vacancy and Credit Loss

When you analyze a property’s income and cash flow, you’ll generally start from the top down, so it is useful to picture the calculation like this:

Gross Scheduled Income

less Vacancy and Credit Loss

= Gross Operating Income

Example

You have a property that is fully rented and takes in revenue of $5,000 per month. You expect a vacancy and credit loss of 3%. What is the GOI?

You first need to know the gross scheduled income. You have no vacant units to account for in calculating the gross scheduled income, so you can multiply the monthly income of $5,000 by 12 to find the annual amount:

Gross Scheduled Income = 12 × 5,000 = 60,000

Next, you need to figure the vacancy and credit loss, which in this case you estimate to be 3% of the gross.

Vacancy and Credit Loss = 60,000 × 0.03 = 1,800

Now you have a simple subtraction to perform:

Test Your Understanding

You have a property with 12 units.

•  Units #1 through #4 each rent for $1,400 per month.

•  Unit #5 rents for $1,200 per month. In month 10, the rent will increase to $1,350.

•  Units #6 though #9 each rent for $1,600 per month.

•  Unit #10 is vacant. Its fair market value is $1,500 per month.

•  Unit #11 rents for $1,600 per month but will be vacant at the end of month 9. The market value of this unit when it becomes available will be $1,600 per month.

•  Unit #12 rents for $1,275 per month.

You estimate a vacancy and credit loss of 7%.

What is the property’s GOI? Does the allowance for vacancy seem reasonable?

Answer

According to the formula, you must first determine the gross scheduled income and the vacancy loss. Then you can find the difference, which is the GOI.

Gross Scheduled Income

less Vacancy and Credit Loss

= Gross Operating Income

•  Units #1 through #4 each rent for $1,400 per month, or $16,800 per year. There are four such units, so their combined rent is 4 × 16,800, or 67,200.

•  Unit #5 will rent for nine months at $1,200 and for the last three months at $1,350: (9 × 1,200) + (3 × 1,350) = 14,850 for this unit.

•  Units #6 through #9 each rent for $1,600 per month, or $19,200 per year. There are four such units, so their combined rent is 4 × 19,200, or 76,800.

•  Unit #10 is vacant, but its market rent is $1,500 per month, or $18,000 per year. You expect to find a tenant at that rent by month 5.

•  Unit #11 rents for $1,600 per month but will go vacant at the end of month 9. However, its market rent will still be $1,600, so this unit represents 12 × 1,600, or 19,200, in scheduled rent.

•  Unit #12 rents for $1,275 per month, or $15,300 per year.

You now have the total scheduled rent for all the units and can add them up to get the gross scheduled income:

Now figure the vacancy and credit loss:

Vacancy and Credit Loss (in dollars) =

Gross Scheduled Income × estimated % Vacancy and Credit Loss

Vacancy and Credit Loss = 211,350 × 0.07 = 14,795

The rest is just subtraction:

Finally, does the vacancy and credit loss seem reasonable? In the previous chapter, we talked about vacancy and credit losses around 3 to 4%. Why should you be assuming 7% here? You can’t ignore the facts that are in the example, and when you analyze a real property, you must not ignore its real circumstances. Unit #10 is vacant, and you expect it to remain so for four months, perhaps to undergo renovations. Whatever the reason, if you assume, as the example states, that it will be empty, then you’ll lose $6,000 in rent for that period. Similarly, you expect to lose three months’ rent from Unit #11, or $4,800. Combined, these predicted vacancies represent just over 5% of the gross scheduled income, so an allowance of 7% is indeed reasonable.