Gross rental income (GRI) is defined as the income a property can earn given the rent that it can command from the market and assuming full occupancy over the investor’s planned holding period.
GRI can be misleading in terms of the actual income-earning capacity of a property because it does not account for potential vacancy and bad collection losses.
To demonstrate the calculation of the GRI consider a two unit property with the one unit (unit A) currently renting at £500 per month with one more year before the expiration of the lease and the other unit (unit B) being vacant. Consider also that the investor’s expected holding period is one year. Therefore the gross rental income can be calculated as:
GRI = GRI for unit A + GRI for unit B
Obviously for the calculation of the GRI for unit B we need to make an assumption/estimate of the rent that can be achieved given the prevailing market conditions. Obviously the best proxy for estimating the potential rent that Unit B can command is the rent achieved on Unit A, if the two units are similar in terms of quality and number of bedrooms. If the lease contract for Unit A has been signed recently and there was no significant change in local housing market conditions, then the analyst can use the rent paid for Unit A as proxy for the rent that can be obtained for Unit B. If unit B is different from unit A then the analyst needs to look at recent lease transactions of similar units in the local market to form a basis for an estimate of the rent that unit B can reasonably achieve.
For the sake of demonstrating the calculation of the Gross Rental Income for this property let’s assume that the estimate of the potential rent that unit B can achieve in the market at the time of analysis is £450. Then, GRI for this property for the next 12 months can be calculated as:
GRI = 12 × 500 + 12 × 450 = 6,000 + 5,400 = 11, 400
Notice that if we want to calculate the property’s GRI for the next three years instead of one then the analyst will need solid forecasts of local housing rents. Using achievable rents today for the next three years will provide inaccurate estimates of GRI if rents are on a rising or declining path.
GRI is rarely a good indicator of the actual income earning capacity of a property for a number of reasons. For example, when dealing with large multi-tenant properties, such as high rise apartments and office buildings, only rarely we have 100% occupancy, which means that in most cases there are some vacant units when the property is acquired. Furthermore, it is highly unlikely that most of the leases in such properties will expire after the planned holding period unless it is a very short one. So, as different leases expire, the vacancy of the property may increase if the market is deteriorating and demand is declining.
Typical income analysis of a property investment starts with the estimation of gross rental income but continues with the estimation of net operating income (NOI), which is the typical measure used for assessing the true income-earning capacity of a property.