If calculated correctly, Loss to Lease entries will have no effect on Effective Gross Income
collected on a property.
In most assignments, the monthly gross income is estimated based on the total amount of income the property can produce at 100% occupancy, i.e., potential gross income rather than effective gross income
. Allowances for vacancy and collection loss--whether estimated or actual--are seldom deducted unless there are reasons for major differences in occupancy rates.
Given the relative age and condition of the subject property, operating expenses were estimated at 28.7% of effective gross income
. Using data from comparable sales and a national investor survey, the overall capitalization rate of the subject property was indicated at 8.50%.
The right side shows that both effective gross income
(EGI) and operating expense (OE) relate to the occupancy rate.
Table 1 ABC Multi-Family Realty Trust Quarter Line ($M) 1 Rental revenue from continuing operations $85.0 2 Plus: Property-related ancillary income 3.3 3 Plus/Minus: Straight-lining of rent 0.0 4 Plus/Minus: Adjustment per FASB regulations 0.0 5 Minus: Lease termination fees received (0.0) 6 Subtotal: Effective gross income
$88.3 7 Minus: Operating expenses, incl.
Vacancy and collection loss is estimated at 5%, and total operating expenses, including property tax, insurance, maintenance, and management are about 35% of effective gross income
Table 1 Known facts Building size Price Reported [R.sub.o] Occupancy Market rent Initial estimates Benchmarked expenses This information generates Price [R.sub.o] Implied NOI Benchmarked expenses Implied effective gross income Effective gross income
per square foot Known facts 100,000 square feet $10,000,000 11.0% 80% $15.00 per square foot per year Initial estimates $6.50 per square foot per year This information generates $10,000,000 11.00% $1,100,000 650,000 $1,750,000 $17.50
Add all appropriate operating expenses to arrive at the effective gross income
. Adjust for vacancy and credit loss to arrive at the required gross income.
Using the illustration presented in table 2 and a land rental rate of 15% of the gross income produces an effective gross income
PGI = Potential gross income V&RL = Vacancy and rent loss EGI = Effective gross income
OE = Operating expenses NOI = Net operating income DS = Debt service + interest BTCF = Before-tax cash flow TAXES = Federal and state income taxes ATCF = After-tax cash flow
The effective gross income
multiplier (EGIM) and potential gross income multiplier (PGIM) should be compared with market norms for the property type.
Potential rental income ("net rent") $ 72,500 Potential expense recoveries Properly tax (pass through to tenants) $30,935 Other expense (pass through to tenants) + $21,565 Total (pass through to tenants) $ 52,500 Potential gross income (PGI) $125,000 Less vacancy and credit loss [at] 10% - $ 12,500 Effective gross income
(EGI) $112,500 Less operating expenses Property tax (total) $ 30,935 Other operating expense (total) + $ 21,565 Total operating expenses $ 52,500 Net operating income (NOI) $ 60,000 Indicated market value ($60,000/0.12) $500,000