Definition: A real estate investment term, Gross Operating Income refers to the result of subtracting the credit and vacancy losses from a property’s gross potential income.
AKA: Effective Gross Income (EGI)
The single biggest draw for real estate rental property investors is regular positive cash flow. It’s all about that cash going into the bank every month. Sure, we want the property to appreciate in value as well, but we can buy and hold stocks to get that result (well usually).
Before you can get to Gross Operating Income, GOI, you start with Gross Potential Income, GPI. Potential is self-explanatory in a way. It is potential income, but it isn’t necessarily reality.
GPI is the expected rent you will receive in a year from your rental property if it is rented the entire 365 days, and if the tenants pay their full rent as agreed.
Now we get to the reality part. Rental properties do not stay rented 365 days every year. Nor do tenants always pay their full rent as they agreed in the lease. Stuff happens. Tenants move out, sometimes with notice and sometimes not. The point is that between tenants there is a period when you’re not going to be getting paid rent. For that period of time you will experience what we call “vacancy loss.” It is the lost income for the period you do not have a tenant paying rent.
So, the first thing we deduct from GPI to get to GOI is the lost rental income when the property is empty.
If you’ve owned rental properties for a while, you will have some experience numbers to help you to estimate this number. Obviously it will vary, but when you’re predicting income into the future, that GOI, you need to have some idea of what you will experience for vacancy loss.
Next we have to consider that not every rent check will arrive, or that they will but they won’t clear the bank. This is rarely a higher cost than vacancy loss, but don’t think you won’t experience it from time to time. We all know it’s just an estimate anyway, as next year’s tenants are different than last year’s.
Controlling Both of Our Variables
One important factor in reducing vacancy loss is keeping a close watch on your properties to make sure they stay in good condition. When someone does move out, you want a process in place that will get that unit ready for a new tenant quickly. You should always be marketing, as it’s better to be telling callers you will not have a vacancy until sometime in the future than it is to wait for calls with a unit empty.
For credit loss, the first obvious thing is to do credit checks on applicants. Also check their references from past landlords if they have them. Not leasing to a higher risk tenant is the most effective way to cut credit losses.
Constantly working to narrow the gap between Gross Potential Income and Gross Operating Income is how you will over time maintain low vacancy and credit loss numbers.