In appraising income-producing residential properties (such as apartments), gross income multipliers are used as a method of determining an opinion of value. Depending on your area, however, the multiplier can be based on potential gross income or effective gross income. Here is the difference between the two.
Potential Gross Income
Potential gross income (also known as PGI or gross potential rent) is the total revenue a property could generate if 100% leased at market rent. This may or may not be what is actually happening with the subject property, but many times this is not the case. For example, some rents may be over or under market, or the property may not be 100% occupied. Nevertheless, PGI reflects the the most annual rent a property would collect.
Effective Gross Income
Effective Gross Income (of EGI) is the amount of income a property generates after other factors are considered. Depending on the property type, the first factor are expense reimbursements, which are operating expenses that are paid for by the tenant. This could include a portion of the expenses (such as real estate taxes and insurance), or, in the case of an absolute net lease, all of the expenses. Expense reimbursements depend on the terms of the lease, but in the case of multifamily properties the tenant is generally only responsible for paying their pro-rata share of the utilities.
Another item to consider is vacancy and collection loss. Vacancy occurs when all or a portion of the property is not occupied, while collection loss is an estimate of how much rent is expected to not be collected during the projection period. This is typically estimated based on the subject’s historical performance, comparable properties, and/or industry benchmarks.
The last item to consider would be other income, which can include parking, laundry income, vending machines, and other types of income not included in the rent. Similar to vacancy and collection loss, other income is typically based on historical figures and comparable properties.
In short, potential gross income is the total rent a property could generate is 100% leased at market rent, while effective gross income is a net figure that considers expense reimbursements, vacancy and collection loss, and other income. In estimating these two figures, especially EGI, it is best to determine what income is affected by vacancy. For example, some other income (like rent from a billboard), is not necessarily affected by occupancy. However, items such as expense reimbursements could be affected if there is a higher than typical vacancy rate. When performing due diligence on a property, an appraiser would look at both historical numbers and the property’s competitors in estimating market value for the subject.
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