PGI Calculates The Potential Income of A Property, Excluding Vacancy and Credit Loss
Potential Gross Income, or PGI, is the maximum amount of income a rental property can generate under ideal market conditions. Sometimes, Potential Gross Income is referred to as Gross Potential Income (GPI) or Gross Scheduled Income (GSI).
The formula for Potential Gross Income is:
Potential Gross Income (PGI) = (Market Level Rent Per Unit * Number of Units) + Potential Maximum Additional Property Income
For example, if an investor owns an apartment building with 20 units, each generating $1,200/month in rental income (the current market level rent), and can generate a potential maximum additional income of $1,000 per month, the annual PGI of the property would be $300,000.
Potential Gross Income (PGI) = ($1,200 Income Per Unit * 12 Months * 20 Units) + ($1,000 Monthly Additional Income * 12 Months) = $300,000
In this article, we’ll look at the calculation assumptions of GPI and compare it to other important rental income metrics, including Gross Potential Rent (GPR), Effective Gross Income (EG), and Net Operating Income (NOI).
Potential Gross Income (PGI) Calculation Assumptions
When calculating Potential Gross Income, you will need to make a few assumptions, including:
Occupancy is at 100%
All tenants are paying their rent on time
Rent is set at market level or above
No rental rebates or rental incentives have been provided
There are no major issues or repairs that must be conducted
Therefore, PGI is an ideal number and is unlikely to be the true income that a property generates, particularly due to the fact that most buildings never reach 100% occupancy. With apartment occupancy rates higher than ever, this is less of a worry for multifamily investors.
However, for example, retail properties generally have higher vacancy rates than apartments, which may lead owners to provide rental incentives, such as months of free rent, or covering additional built-out expenses. In addition to potential vacancy issues, there are often at least some tenants that may not pay on time or may stop paying rent entirely for some period of time.
Potential Gross Income vs. Gross Potential Rent (GPR)
PGI can also be differentiated from Gross Potential Rent (GPR), as PGI uses all potential sources of income a property may generate, including parking fees, vending machines, or other services, while GPR only calculates direct rental income from tenants.
For example, the Gross Potential Rent of the property in the example above would be:
Gross Potential Rent (GPR) = ($1,200 Income Per Unit * 12 Months * 20 Units) = $288,000
Potential Gross Income vs. Effective Gross Income (EGI)
Effective Gross Income is a metric that takes into consideration all the current rental and additional income of the property, but, unlike Potential Gross Income, it factors in credit loss, vacancies, and other rental-related losses (i.e. rental concessions, incentives, and abatements). However, it does not calculate core operating expenses.
If we take the example of the apartment building in the section above and say that the property is at a 95% occupancy rate, that each unit was given 1 month of free rent, and that additional income was $500/month, the Effective Gross Income of the property would be.
Effective Gross Income (EGI) = ($1,200 Income Per Unit * 0.95) * (11 Months * 20 Units) + ($500 Monthly Additional Income * 12 Months) = $256,800
Potential Gross Income vs. Net Operating Income (NOI)
In contrast to PGI, Net Operating Income (NOI) is a metric that represents a building’s actual income, by taking all operating income and subtracting operational expenses. NOI is also different from Effective Gross Income (EGI) as NOI takes into account operating expenses, including covered utilities, insurance, taxes, repairs and maintenance, and perhaps most importantly, property management expenses.
The formula for NOI is:
Net Operating Income (NOI) = Gross Operating Income (or Effective Gross Income) – Operating Expenses
If we continue the example from above, and say that property management expenses equaled 10% of gross rents, insurance costs were $20,000 annually, covered utilities equaled $50/occupied unit per month, and property taxes were set a 2% of the appraised value (let’s say $3 million), and repairs, and maintenance cost $10,000 per year, the NOI would be $160,200.
NOI = Gross Operating Income of $256,800 - $20,000 Insurance Costs - ($50 * 12 Units * 95% Occupancy (0.95) - ($3,000,000 Appraised Value * 2% (0.02) Property Taxes) - $10,000 Maintenance Costs = $160,200
It should be noted that NOI does not factor in mortgage expenses, as these are not considered operating expenses.
What Potential Gross Income Does Not Calculate
Potential Gross Income is an important investor metric, but, in most cases, NOI is a more realistic metric when attempting to compare similar investments. PGI is rather limited in the fact that it uses in ideal conditions and does not factor in vacancies, credit loss, or operating expenses. This is why, for example, NOI is used instead of PGI or EGI when calculating a property’s cap rate.
PGI is also not a good metric to determine the Return on Investment (ROI) of a property. Instead, ROI can be calculated using metrics such as IRR, Equity Multiple, or Cash-on-Cash Return.