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Sunday, January 4, 2015

Weekly Investment Term #9

One of the asset class that's not mentioned as often in this blog is property. Today, we will try to talk a bit about one of the common metric that's being used to evaluate the value of a piece of investment property.

EFFECTIVE GROSS INCOME is a metric commonly used to evaluate the value of a piece of investment property. It's calculated by adding the amount of income produced by the piece of property and the miscellaneous income, less vacancy costs and collection losses. 

Here is an example:

A condominium has an income of $1,000,000 if it is able to rent out all of its units (full occupancy). Historically, the condominium is unable to fill 10% of its units, meaning that it is unable to collect $100,000 ($1,000,000 * 0.1). 

The Effective Gross Income for the property is $1,000,000 - $100,000, = $900,000

Some things to ponder when calculating EGI is the factors that can influence the vacancy costs and collection losses for a piece of property. There is a need for investors to estimate the costs of the income lost what can be generated but the market might cause this to fluctuate up or down. 

When looking to purchase investment property, potential investors use the Effective Gross Income to gauge the expected amount to be paid for the property and the expected earnings from it. Low Effective Gross Income and high costs are a sign to reconsider about buying the property, vice versa for high Effective Gross Income and low costs.

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