How to Calculate Gross Operating Income
Gross operating income is what you’d make as a landlord by renting a property for a year after taking away some losses. The first step in calculating gross operating income for a rental property is to determine its gross potential income.
Formula and Example of Gross Operating Income for Rental Property
You can use a simple formula to calculate gross operating income for your rental. Gross operating income = Gross potential income - vacancy loss - credit loss Let’s consider an example. You’ve got three apartments in building A that you would like to rent for $700/month and three apartments in building B that you’d like to rent $800/month. If all apartments get rented, all through the year, here’s what your gross potential income would look like. Monthly potential rent from building A= 3*$700 = $2,100Annual potential rent from building A= $2,100 12= $25,200 Monthly potential rent from building B= 3$800 = $2,400Annual potential rent from building B= $2,400 *12= $28,800 Gross potential income from both buildings = $25,200 + $28,800 = $54,000 Now assume our losses due to vacancies and non-payment will be 5%. Then loss due to vacancy would be $2,700 ($54,000 *.05). Plugging those numbers in the formula for gross operating income, we get: Gross Operating Income = $54,000 - $2700= $51,300
It’s All About Income
Let’s think about the rental property investment and break down the two major components, income and expense. We’ll start with expenses. The expenses that are involved in rental property investment are some cash and others accounting entries, such as depreciation. So, not every expense is cash out of pocket. The actual ownership and operating costs include:
taxesmortgage interestmarketing and advertisingmanagement expenseslegal and accountingsome utilitiesrepairs and maintenancevacancy and credit losscosts of acquisition and sale
Those are all pretty well-defined, and we have some control over some of them. We can shop and negotiate some of them to reduce those expenses. The point is that they are going to have what we can pretty accurately estimate as maximum amounts we can use in ROI and profit calculations. They aren’t things we can change dramatically; that is unless you can get taxes repealed or lawyers and accountants to work for free. When it comes to income, however, things are less quantifiable because we have more opportunity and a little more control. Let’s think about some of the ways in which income is determined and variable.
The Initial Property Acquisition
How well we do our due diligence to locate bargains is the first control we can exercise over income. Not only is it about finding a bargain, but also about knowing the best location, neighborhood, and property characteristics will be best for rental. Once you figure out where to buy, you do your research and locate possible properties. You do some more due diligence and a whole lot of calculations. Once you find the right one, it’s time to negotiate your way to a price that’s below current market value.
Setting the Right Rent
Now, it’s easy just to say, get as much as possible, but that’s not necessarily the best approach. You take into account the prevailing rents and how your property fits in with features and competitive edge. Then calculate your losses when the property is vacant between tenants. You see, if the rent is set too high, you will probably experience more vacant time so that you may lose all or even more of your gains from the higher rent. That’s control, and you have some.
Tenant Relationships, Advertising, and Management
Now that you have tenants in place, keeping them as long as possible at prevailing rents is a great approach, and you have some control of that. Great tenant relations, excellent service, good complaint handling techniques all come together as management techniques to maximize income. As you can see, you have more things you can influence or control on the income side than on the expense side. Spend the time necessary to get the expense side tightened up, but concentrate on the income side items to get the most out of your rental investment.
