Effective Gross Income (EGI): Definition, Formula and Example
When underwriting a commercial property, there are two ways to look at rental income: what a property could earn in a perfect world, and what it realistically earns after accounting for vacancy and tenants who don’t pay. Effective gross income (EGI) is the second figure — and it’s the one that actually matters for valuation and investment analysis.
EGI sits at the foundation of every credible commercial real estate financial model. Get it wrong and every metric downstream — NOI, cap rate, property value — is off.
What Is Effective Gross Income?
Effective gross income is the total income a property is expected to generate over a given period, after deducting vacancy allowances and credit losses from gross potential income, and adding any ancillary income sources beyond base rent.
In plain terms: it’s the realistic revenue number — not the optimistic one.
EGI reflects what a property owner can reasonably expect to collect, as opposed to what they’d collect if every unit were leased at full rent, every day of the year, with no tenant defaults. That theoretical maximum is called potential gross income (PGI) — EGI adjusts it downward to reflect real-world conditions.
Effective Gross Income Formula
The effective gross income formula is:
EGI = Potential Gross Income (PGI) + Other Income − Vacancy Allowance − Credit Loss
Where:
Potential Gross Income (PGI) = Total Rentable SF × Market Rent per SF × 12 months
Or broken out step by step:
- Start with Potential Gross Income — the theoretical maximum rental income if the property is 100% occupied at contracted rents year-round
- Add Other Income — all ancillary revenue streams beyond base rent
- Subtract Vacancy Allowance — estimated income lost to unoccupied space
- Subtract Credit Loss — estimated income lost to tenant non-payment or partial payment
The result is Effective Gross Income — the realistic revenue baseline used in all further analysis.
Components of EGI Explained
Potential Gross Income (PGI)
PGI is the starting point — the total rent the property would generate if fully occupied at contracted rent rates for the entire year. For a 20,000 sf office building leased at $4.00/sf/month, PGI would be $960,000 annually ($4.00 × 20,000 × 12).
PGI uses contracted rent, not market rent, for occupied space. For vacant space, market rent is used to project what that space could generate if leased.
Other Income
Other income captures all revenue beyond base rent. In commercial real estate this typically includes:
- Parking fees — particularly significant in urban office and retail properties
- Signage and antenna income — rooftop or façade leasing rights
- Storage unit fees
- Common area vending or amenity revenue
- Tenant reimbursements — in some lease structures, tenants reimburse operating expenses above a base year, which flows through as additional income
The composition of other income varies considerably by property type. A suburban office campus may generate substantial parking revenue; a NNN retail property may have virtually none.
Vacancy Allowance
No property stays fully occupied indefinitely. The vacancy allowance is an estimate of the income lost to unoccupied space during the analysis period. It’s typically expressed as a percentage of PGI — a 5% vacancy allowance on a $1,000,000 PGI reduces income by $50,000.
Vacancy allowances should be based on:
- Historical occupancy at the specific property
- Current and projected market vacancy rates in the submarket
- Lease expiration schedule — properties with near-term lease rollovers carry higher vacancy risk
- Property type and quality — Class A assets in tight markets may warrant lower vacancy assumptions than older Class B or C product
Credit Loss
Credit loss (sometimes called bad debt allowance) accounts for the risk that occupied tenants don’t pay their full contracted rent. A tenant may be in arrears, negotiating a rent deferral, or in default. Unlike vacancy — where the space is physically empty — credit loss occurs when the space is occupied but income isn’t collected.
In commercial real estate, credit loss is typically smaller than vacancy loss but shouldn’t be ignored entirely, particularly for properties with weaker tenant credit profiles or shorter lease terms.
Effective Gross Income Calculation: A Commercial Example
A 50,000 sf office building in San Francisco is leased at an average of $3.80/sf/month. The building has a parking structure generating $120,000 annually and roof antenna income of $18,000 per year. Market vacancy for comparable assets in the submarket is 8%, and the owner applies a 1% credit loss allowance based on the tenant roster.
Step 1 — Potential Gross Income: 50,000 sf × $3.80/sf/month × 12 months = $2,280,000
Step 2 — Other Income: Parking: $120,000 + Antenna: $18,000 = $138,000
Step 3 — Gross Revenue Before Deductions: $2,280,000 + $138,000 = $2,418,000
Step 4 — Vacancy Allowance (8% of PGI): $2,280,000 × 8% = $182,400
Step 5 — Credit Loss (1% of PGI): $2,280,000 × 1% = $22,800
Effective Gross Income: $2,418,000 − $182,400 − $22,800 = $2,212,800
This is the figure used as the revenue input in the property’s NOI calculation — not the $2,418,000 gross figure, and certainly not the $2,280,000 PGI.
EGI vs NOI — What’s the Difference?
EGI and NOI are closely related but measure different things in the income analysis chain.
EGI is the revenue figure — what the property realistically collects before expenses are deducted.
NOI (Net Operating Income) is what’s left after operating expenses are subtracted from EGI.
NOI = EGI − Total Operating Expenses
Operating expenses include property taxes, insurance, utilities, maintenance, repairs, management fees, and administrative costs. They do not include debt service, depreciation, or capital expenditures.
EGI feeds directly into NOI, which in turn feeds into cap rate valuation and DCF analysis. Errors at the EGI stage compound through every subsequent calculation — which is why accuracy in vacancy and credit loss assumptions matters as much as the rent figures themselves.
| Metric | What It Measures |
|---|---|
| PGI | Maximum theoretical income — 100% occupancy, no losses |
| EGI | Realistic income after vacancy and credit loss adjustments |
| NOI | Income after operating expenses are deducted from EGI |
| Cap Rate | NOI ÷ Property Value — investment yield metric |
Why EGI Matters in CRE Underwriting
EGI is the revenue foundation of every commercial real estate underwriting model. Here’s where it shows up in practice:
Property valuation: Since NOI drives cap rate valuation, the accuracy of EGI directly determines whether a property is being valued correctly. An overstated EGI — whether from unrealistic vacancy assumptions or ignoring credit loss — produces an inflated NOI and therefore an inflated property value.
Lender underwriting: Commercial lenders use EGI to assess debt service coverage. A property’s ability to service its mortgage depends on realistic income, not theoretical maximums. Most lenders apply their own vacancy and credit loss assumptions as part of stress-testing borrower projections.
Investment comparison: EGI provides a standardized basis for comparing properties. Two buildings with the same PGI but different occupancy histories, lease profiles, and submarket vacancy rates will have different EGIs — and different investment characteristics.
Pro forma modeling: In acquisitions and development projects, EGI assumptions over a multi-year hold period are critical inputs to IRR and equity multiple calculations. Conservative EGI modeling produces more defensible returns projections.
Frequently Asked Questions
What is effective gross income in real estate? Effective gross income is the realistic revenue a property generates after deducting estimated vacancy and credit losses from potential gross income and adding ancillary income sources. It’s the revenue input used in NOI calculations and property valuations.
What is the effective gross income formula? EGI = Potential Gross Income + Other Income − Vacancy Allowance − Credit Loss. PGI is calculated as total rentable area × contracted rent × 12 months.
What is the difference between EGI and NOI? EGI is the revenue figure — realistic income before expenses. NOI is EGI minus operating expenses. EGI comes first in the calculation chain and feeds directly into NOI.
What is a typical vacancy allowance for EGI calculation? It varies by property type and market. In tight markets with low vacancy, 3–5% is common for stabilized assets. In markets with elevated vacancy — such as San Francisco’s office market currently — 8–12%+ may be more appropriate depending on the property’s lease expiration profile and submarket conditions.
How does credit loss differ from vacancy loss? Vacancy loss occurs when space is physically unoccupied — no tenant, no rent. Credit loss occurs when space is occupied but the tenant doesn’t pay the contracted rent in full. Both reduce EGI but arise from different risk factors.
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