In any field, from the corner store or long-term rentals, the potential gross income is the expected revenue earned from a sale or the rendering of services. The potential gross income definition in real estate refers to all the income a rental property can gain if it is fully occupied, and all rents are collected on time. Real estate investors want to know the amount of revenue they can expect from a property before investing in it. The potential gross income gives them an understanding of what the highest earning can be for any property.
Any landlord will tell you that the perfect rental property in an ideal world has a renter that never runs late on rent, always pays it in full, and continuously renews their lease. Decent, appropriate, and well-behaved renters are also at the top of the list for landlords, but occupied units are better for business. The reason why we speak of a perfect world scenario is that in the real world, landlords need to face vacancies and credit losses. The potential gross income is what the landlord could gain from a property if there were no losses.
When a renter occupies a $1,000/month unit with an annual lease, the landlord would have $12,000 at the end of the year. However, if the renter moves out before the lease is over, the landlord will incur vacancy losses for the vacant unit. It usually takes a landlord one and a half months to find another renter, and at that time, the vacancy losses can go to $1,500. If the renter doesn’t pay their rent before they are evicted, the landlord will incur credit losses as well.
These losses decrease the potential gross income because the unit wasn’t occupied at its full potential. These losses are subtracted from the PGI to get the net operating income (NOI). It’s easy to see why these losses can affect the revenues of a rental property.
When a real estate investor is looking at a property they need to know the potential gains of the property prior to purchasing it. With that information available they will be able to offer a realistic price for the property. The property has ten rental units. The rental fee for five of them is at $700 per month, the other three units can be rented for $900, and the last two are rented at $1,000. We multiply each rental with 12 to get the annual income and add all of them up.
$700 * 12 months = $8,400
$8,400 * 5 units = $42,000
$900 * 12 months = $10,800
$10,800 * 3 units = $32,400
$1,000 * 12 months = $12,000
$12,000 * 2 units = $24,000
PGI = $42,000 + $32,400 + $24,000
PGI = $98,400