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Investors must know the value of a property before committing funds. Importantly, potential gross income (PGI) is a crucial input into value assessment. In this article, we cover:
- The definition of PGI (aka Gross Scheduled Income)
- The Potential Gross Income Formula
- An Example of Gross Scheduled Income
- Gross Scheduled Income vs Effective Gross Income
- How Assets America® Can Help
- Frequently Asked Questions
What is Potential Gross Income?
PGI (aka gross scheduled income) is the total income a property will produce if it fully leases the subject property at the prevailing market rents. Frankly, it is an ideal number, often different from the actual rent that the property produces. Specifically, you may not collect gross scheduled income for various reasons, including:
- Rent is above or below market.
- The occupancy rate is less than 100%.
- Some tenants are not paying their rent.
- The landlord rebates part of a tenant’s rent.
- Part of the property is temporarily not rentable.
Therefore, gross scheduled income is a target number, achievable in some properties and not in others. Ultimately, as we shall see, gross scheduled income is different from effective gross income.
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Gross Scheduled Income vs Effective Gross Income
Effective gross income (EGI) is different from gross potential income. The difference involves three main factors that affect rent collections.
1. Expense Reimbursements
First, tenants pay expense reimbursements. Generally, these may include insurance, maintenance, and real estate taxes. In contrast, an absolute net lease requires the tenant to pay all expenses.
2. Collection and Vacancy Loss
Secondly, a factor that reduces PGI to EGI is collection and vacancy loss. Collection loss is the projected amount of rent that you won’t be able to collect for the period. Alarmingly, this could stem from various factors, such as rent strikes, squatters, evictions, and deadbeats.
Vacancy loss occurs when you can’t rent out all of your available units. Alternatively, someone could move out before there is a replacement tenant.
During the lease-up phase of a new property, you must recruit and sign new tenants. Obviously, this takes time, which creates vacancy loss. Clearly, your hope is to stabilize the property at 100% occupancy as soon as possible.
3. Additional Income
Thirdly, other income sources impact EGI. These include income from laundry machines, vending machines, parking, storage units, pet fees, late fees, etc.
Notably, you can estimate the EGI factors using industry benchmarks, comparable properties, and/or historical performance. Appraisers consider all these factors when evaluating properties.
Potential Gross Income Formula
The formula for PGI is:
PGI = Σ (market-level rent per unit x number of units at that rent)
Σ means sum.
This covers all cases in which different units have the same or different rents.
How to Calculate Gross Scheduled Income
Here is how you would calculate gross scheduled income. In a spreadsheet, list all of your units in Column A. For column B, enter the monthly rent for each unit. For Column C, put the product of 12 times B. Finally, sum Column C to arrive at the gross scheduled income.
Video – How to Calculate Potential Gross Income
Examples of Potential Gross Income
Let’s assume you have six units to lease in a small, new office building. Three of the units rent for $700 per month and the other three rent for $1,000 per month. The following table shows the results:
| Unit | Monthly Rent | Annual Rent |
|---|---|---|
| 1A | $700 | $8,400 |
| 1B | $1000 | $12,000 |
| 2A | $700 | $8,400 |
| 2B | $1000 | $12,000 |
| 3A | $700 | $8,400 |
| 3B | $1000 | $12,000 |
| PGI | $61,200 |
In this example, the potential scheduled income is $61,200.
Next let’s calculate the effective gross income for the property:
| EGI Example | |
|---|---|
| PGI | $61,200 |
| Vacancy Loss | ($1,700) |
| Collection Loss | $0 |
| Parking Fees | $7200 |
| Vending Machines | $5000 |
| EGI | $71,700 |
Notice how the fees from parking and the vending machines create a positive addition to PGI. Conversely, we estimate vacancy loss of one month each for an A unit and a B unit. The result is an EGI of $71,700 per year.
Evaluating the Example Property
The example property is an existing building with triple-net leases. You (the landlord) are responsible for other expenses that amount to $10,000/year. Thus, your net operating income (NOI) is $71,700 – $10,000 = $61,700.
The property has a cap rate of 10%. Plugging into the cap rate formula, we find the property value to be $61,700 divided by 10% = $617,000. You bid that amount to purchase the property.
You qualify for a loan-to-value ratio of 70%. Therefore, you must come up with a 30% down payment, equal to 0.3 x $617,000, or $185,100. You receive a loan for the remainder, $431,900, to buy the property.
How Assets America® Can Help
Before you can worry about the rent you’ll collect, you have to own a property. Obviously, that means you must purchase one, build one, and/or renovate one. That’s where Assets America® can help.
We can arrange many sorts of financing for projects or acquisitions starting at $10 million and above. This includes construction loans, bridge loans, acquisition loans, mezzanine loans, mini-perm loans, takeout loans, and more.
Renovation Loans
Loans to renovate properties can be extremely helpful when you want to increase your rental income. With the money you borrow from Assets America®, you can:
- Increase the potential gross income by enhancing existing units to rent for a higher market rate
- Increase the gross scheduled income by increasing demand for your units, thereby increasing occupancy rates
- Reduce the need to make rent concessions because your units are more desirable
- Enhance your ability to receive higher reimbursements for expenses you pay
- Make it easier to move expenses to tenants via triple-net leases and absolute leases
- Increase the quality of your tenants thereby reducing credit costs
Construction Loans
But what if you want to build a new office building or apartment tower? Assets America® can get you the money you need to build upscale, high-quality properties that will command premium rents.
You may find it easier to get more funding from Assets America® than you can from a bank. With increased funding, you can take steps during construction to help ensure top rents, including:
- Building larger properties with greater economies of scale
- Build in the hottest neighborhoods
- Purchase generous-sized parcels of land that allow you to build large properties without undue crowding
- Choose top-quality materials and highly skilled labor
- Provide spacious layouts with premium furnishings, appliances, and amenities
- Include large lobbies, on-premise restaurants and bars, athletic facilities, retail stores, and other value adds
Frankly, that’s an incomplete list. There are many ways to employ funding to build high-rent properties.
If you’d like to find out more about how Assets America® can help, contact us for a confidential consultation.
Frequently Asked Questions
What is GSI in real estate?
GSI, or gross scheduled income, is a synonym for potential gross income. It’s the income you can earn from a rental property under ideal circumstances of market rents and full occupancy.
What should the gross rent multiplier be?
Gross rent multiplier (GRM) is the price of a property divided by its annual rental income. It is in years, and ideally, you’d like it to be four to seven years. That is a typical amount of time to recoup your investment in the property.
What is the monthly gross rent multiplier formula?
The monthly gross rent multiplier is the GRM multiplied by 12. It is in months. It is the number of months it will take to earn back your investment in a rental property.
What are potential pitfalls when using potential gross income?
The biggest pitfall when using PGI is self-deception. Many investors want to picture a large income stream from rent. Therefore, they adopt a rosy scenario involving market rents and extremely high occupancy rates. A good lender like Assets America® can help save you from the risks of self-deception.