When you're looking at an investment property, the income that it can, or should, generate is almost more important than the physical asset. After all, you aren't buying it to occupy -- you're buying it to make a profit. While many investors focus on the net operating income, the gross income numbers that go into the NOI can tell you a great deal about the property's performance and its potential.
Scheduled Gross Income
A property's scheduled gross income, or SGI, represents the highest possible income collection for the property in its current condition. To calculate the SGI, you add up all of the monthly rents for occupied spaces and multiply them by 12 to annualize them. For vacant spaces, calculate what they should rent for in the current market, multiply those rents by 12 to annualize them and add them in. Finally, add in all of the other miscellaneous income that your property earns. Those three factors -- actual rent plus potential rent from vacant spaces plus other income -- make up the SGI.
Effective Gross Income
The effective gross income, or EGI, represents what a property is actually, or effectively, earning. Typically, you take the SGI and subtract out a vacancy and collection factor. For buildings with vacancies, you would subtract out the potential rent that you added in. For full buildings, you take a factor to compensate for the potential for vacancy over the year or for the fact that you may not be able to collect all of the rents that you expect. While vacancy factors can vary, subtracting 5 percent from your SGI is a good rule of thumb.
In a six-plex with five units occupied at a market rent of $700 per month and one vacant unit, the SGI would be $50,400. The $50,400 comes from the $3,500 per month in collections and the $700 a month in rent for the vacant unit multiplied by 12. Subtract the $8,400 in estimated rent for the vacancy from the SGI to find the EGI of $42,000.
Using SGI and EGI
The EGI is useful because it is the basis for the net operating income, which is used in valuing buildings. However, you can use the difference between the SGI and the EGI to evaluate a building's income growth potential. If the building's EGI and SGI are relatively close together, it usually means that the property has strong rents and occupancy, which could mean that you don't have many opportunities to grow the property's income. However, if there is a meaningful gap between them, it could indicate an opportunity for you to fill units or to increase rent rates to market levels.
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