This one is relatively simple. We want to know what income will be realized if a property is fully occupied and all rents are collected. We take number of units times annual rent for a total.
Example: An apartment complex with six units. Three rent for $700 per month and the other three rent for $800 per month.
Time Required: 5 minutes
- 3 units * $700/month = $2100
- $2100 * 12 = $25,200
- 3 units * $800/month = $2400
- $2400 * 12 = $28,800
- $25,200 + $28,800 = $54,000 Annual income. This is the GPI.
What You Need
So, Why Is It Potential Income?
Ask any landlord investor their idea of a perfect rental property world, and the top two things you'll hear will likely be that they want a tenant that pays their rent in full on time and also that they renew their lease over and over again. Then the list would include stuff like well-behaved tenants, stuff not breaking, etc. However, the top two are what we're talking about here.
They're related to vacancy and credit losses. That's the lost income when rent isn't being paid, either because they just aren't paying or because the unit is empty. Let's think about a situation where you lose a tenant without a lot of warning, and you advertise for a new one. Unfortunately, it takes you a month-and-a-half to get them moved into the home and the rent flowing again.
If your rent is $800/month ($9,600 per year), that vacancy period would reduce your income by $1,200 for the month-and-a-half. That's 12.5% of your entire year's revenue. It could be even worse if they had stopped paying rent for a month and you finally got them out; now you're at two-and-a-half months' lost income. That's $2,000, or a 21% loss in revenue.
You can see that vacancy and credit loss can be quite damaging to your return on investment (ROI) for the property. And, we're not even considering the normal refit and prep for a new tenant that happens every time a lease expires, and the tenants move out. You probably have some wall work, painting, and at the least a cleaning fee.
How Damaging Can It Be?
We're not trying to scare anyone, but you should understand the effects of non-payment of rent and vacancy time. Many investors are thrilled to get a double-digit return on a rental property investment. Even if calculated just on cash invested (down payment and closing costs), it's a nice situation to see a 20% to 30% return.
But, as you can see from our lost rent example above, you're taking a significant hit when you're losing 12% to 20% of your revenue. Don't let it keep you from investing, but always try your best to get the best tenants, interview and vet them well, and get as much notice as you can before they move out.
Now that we've thrown a wet blanket over your thoughts of becoming a wealthy rental baron let's take a minute to think about why real estate, and particularly rental properties, is such a great way to build wealth. Don't forget about:
- Regular monthly cash flow
- Value appreciation over time
- Tax advantage of deducting expenses of marketing, management, and operation:
- property taxes
- mortgage interest
- advertising expenses
- management expenses
- repair and maintenance expense
- The tax break from depreciation
- Grow your portfolio with the 1031 Tax Deferred Exchange
It's a great way to invest. Just do your best to get and keep good tenants.