Effective Rent & Economic Vacancy

Gross potential rent is a ceiling, not a forecast

Every rental analysis starts with a number, and it's tempting to start with the wrong one. Take the asking rent — say $2,200 a month — multiply by twelve, and treat $26,400 as the property's income. That figure has a name: gross potential rent (GPR), your assumed market rent times twelve across all units. But GPR is the modeled potential at your assumed market rent — not the revenue forecast. It's the income the property would produce if every unit were full every day of the year, every tenant paid in full and on time, and you never gave a dollar of concession. Using GPR as if it were expected collected rent ignores the normal gap between potential revenue and the revenue you actually collect.

What you want instead is effective gross income (EGI) — the underwritten top-line forecast after your vacancy and credit assumptions and other income. Getting from GPR to EGI means subtracting what you don't expect to collect and adding the smaller income streams you do. Before the arithmetic, though, one distinction does most of the work.

Physical and economic occupancy measure different things

Physical occupancy measures time: occupied unit-time ÷ available unit-time — is the unit occupied? Economic occupancy measures dollars: base rent actually collected ÷ GPR. They answer different questions, so they can diverge. A unit can be physically occupied and still not collecting full modeled rent — a tenant on a below-market lease, a concession like a free month, or rent that's owed but not paid — which pushes economic occupancy below physical. (The reverse is possible too: because GPR is built on an assumed market rent, a lease signed above that assumption can push economic occupancy slightly above physical.) In ordinary underwriting, the downward effect of concessions and collection losses is the larger one, so economic occupancy is usually the lower of the two. That isn't guaranteed by the definition, though. Either way, the dollar version is the one to underwrite a deal on: a property can be "95% occupied" by the door count and materially different by the dollar.

A related discipline: keep delinquency and bad debt — billed rent you never collect — tracked separately from vacancy. They land in the same place (less cash), but they're different problems with different fixes (leasing and pricing on one side, screening and collections on the other), and blending them hides which one is hurting you.

Building effective gross income

The build is short. Effective gross income = gross potential rent − vacancy and credit loss + other income. Vacancy and credit loss is your allowance for empty time plus uncollected rent — a percentage of GPR you set from the market and the property's evidence, not a hopeful round number. Other income is the smaller, real money a rental throws off: late fees, pet rent, parking, laundry. Add it back because it's income you expect to bank. What's left, EGI, is the underwritten top line — and it's the number every downstream metric should be built on. (After you own the property, you compare the actual collected revenue against this forecast; at underwriting, it's an estimate.)

Watch it work on the example rental these guides use throughout, an illustration rather than a forecast. Market rent is $2,200/month, so GPR = $26,400. Apply the example's 6% vacancy-and-credit-loss assumption — that's −$1,584 — and add $300 of other income for the year. EGI = $25,116. (The example's full assumption set is listed in The Operating-Expense Build & the 50% Rule.) That $1,284 gap between the asking-rent headline ($26,400) and the underwritten top line ($25,116) isn't pessimism; it's the difference between the year you model at full potential and the year you actually underwrite.

And here's the part that matters downstream: the revenue line is overstated by only about 5% in this example, but that error doesn't stay 5% as it flows down — because many costs are fixed, the distortion amplifies. Hold the example's operating expenses at $9,600. Net operating income (NOI) is what the property earns after operating costs and before loan payments. Real modeled NOI is $25,116 − $9,600 = $15,516, but plugging in GPR instead gives $26,400 − $9,600 = $16,800 — about 8.3% too high, not 5%. And when cash flow sits near zero (as it does here), the percentage distortion in cash-on-cash return, a year's cash flow as a share of the total cash you put in, can be far larger still. A small overstatement at the top becomes a big one at the bottom.

Where asking rent still has a job

Two boundaries keep effective rent in its place. First, this is a revenue step only. Expenses, the management allowance and the capital expenditure (CapEx) reserve belong to the operating-expense build, and the returns to Normalized NOI & Cap Rate and Cash-on-Cash Return; effective rent is the top line that feeds them. Second, asking rent still has a job — as a screen and a ceiling. It tells you the property's upper bound and lets you compare listings quickly. It just isn't the number you underwrite. Use it to decide what's worth a closer look; use effective gross income to decide whether the closer look pencils.

Gross potential rent is the modeled year at full potential; effective gross income is the year you actually underwrite. Subtract a vacancy-and-credit-loss allowance drawn from the property's evidence, add the other income you expect to collect, and underwrite that. It's the least glamorous number in the analysis, and getting it right is what keeps every metric built on top of it reliable.