======Effective Gross Income (EGI)======
Effective Gross Income (EGI) is the realistic annual income a property is expected to generate //before// any operating expenses are paid. Think of it as the money you //actually// anticipate collecting from an investment property, not the pie-in-the-sky number you'd get if every unit was rented out every single day to a perfect, always-paying tenant. That fantasy number is called [[Potential Gross Income (PGI)]]. EGI brings things back down to earth by subtracting an allowance for [[Vacancy and Credit Loss]]—covering empty units and tenants who unfortunately don't pay their rent. For a [[Value Investing|value investor]], EGI is a critical first step in property analysis. It cuts through sales hype and provides a sober, conservative estimate of a property's true earning power. It's the foundation upon which more important metrics, like [[Net Operating Income (NOI)]], are built, ensuring you're valuing the property based on what it's likely to produce, not what it //could// produce in a perfect world.
===== The Nitty-Gritty of EGI Calculation =====
Calculating EGI is a straightforward process of starting with the maximum possible income and then adjusting for real-world imperfections.
==== Start with Potential Gross Income (PGI) ====
First, you determine the [[Potential Gross Income (PGI)]]. This is the total annual rental income the property would produce if it were 100% occupied for the entire year, with all tenants paying their rent in full and on time.
  * **Example:** A 10-unit apartment building where each unit rents for €1,000 per month has a PGI of €120,000.
  * (10 units x €1,000/month x 12 months = €120,000)
==== Add Other Income ====
Next, you add any other income the property generates. This is money earned from sources other than rent. Common examples include:
  * Fees from parking garages or reserved spots
  * Revenue from on-site laundry machines
  * Vending machine commissions
  * Late fees or pet fees
Let's say our 10-unit building generates an extra €5,000 a year from laundry and parking fees. Our total potential income is now €125,000.
==== Subtract for Reality: Vacancy and Credit Loss ====
This is the most important step. No property stays 100% full forever, and occasionally, a tenant will fail to pay. You must account for this. A common practice is to use a percentage of the PGI. This [[Vacancy and Credit Loss]] rate can be based on the property's history, the average for the local market, or a conservative estimate if you're a cautious investor. A 5% to 10% rate is a typical starting point.
==== The Formula in Action ====
The complete formula is:
**EGI = (Potential Gross Income + Other Income) - Vacancy and Credit Loss**
Let's finish our example using a 5% vacancy and credit loss rate on the PGI portion:
  - **Total Potential Income:** €120,000 (PGI) + €5,000 (Other Income) = €125,000
  - **Vacancy/Credit Loss:** €120,000 (PGI) x 5% = €6,000
  - **Effective Gross Income (EGI):** €125,000 - €6,000 = **€119,000**
As you can see, the EGI of €119,000 is a much more dependable figure for analysis than the initial PGI of €120,000 or the total potential of €125,000.
===== Why EGI is a Value Investor's Best Friend =====
EGI isn't just a line item on a spreadsheet; it's a mindset that promotes disciplined investing.
==== A Reality Check on Your Investment ====
Relying on PGI is a classic rookie mistake. It inflates a property's appeal and can lead to overpaying. EGI forces you to be realistic about potential [[Cash Flow]]. By acknowledging that things can and do go wrong (like vacancies), you're building a [[Margin of Safety]] directly into your calculations. This protects your downside and is the hallmark of intelligent investing.
==== The Gateway to True Profitability ====
EGI is the essential bridge to calculating [[Net Operating Income (NOI)]], one of the most important metrics in real estate. The formula is simple: **NOI = EGI - Operating Expenses**. Without an accurate EGI, your NOI will be wrong. A correct NOI is fundamental for:
  * Determining a property's profitability.
  * Comparing different investment properties.
  * Calculating the [[Capitalization Rate (Cap Rate)]], a key valuation tool.
===== A Quick Example: The Tale of Two Buildings =====
Imagine two nearly identical apartment buildings for sale, both priced at $1 million.
  * **Building A (The Dream):** The seller's brochure boasts a PGI of $100,000. But a quick check of the area reveals a high 15% vacancy rate.
  * **EGI for Building A:** $100,000 - (15% of $100,000) = **$85,000**
  * **Building B (The Stalwart):** The owner presents a PGI of $95,000. However, the building is well-managed with long-term, happy tenants, leading to a very low vacancy and credit loss of just 2%.
  * **EGI for Building B:** $95,000 - (2% of $95,000) = **$93,100**
Despite having a lower "potential" income, Building B has a significantly higher //effective// income. The value investor, focusing on the realistic EGI, immediately sees that Building B is generating more cash and is likely the far superior investment. EGI helped uncover the true story behind the numbers.