One of the major factors in the success of a commercial real estate investment is the amount of income it produces. However, it can be a little bit tricky to measure because there are a number of metrics that real estate investors should be familiar with.
In this article, we are going to describe one of those metrics, known as Gross Potential Rent, or GPR for short. We will describe what it is, how it is calculated, and why it matters in the evaluation of a potential commercial real estate property investment. By the end, real estate investors will have the information needed to incorporate this calculation into their own pre-investment due diligence process.
At First National Realty Partners, we specialize in the acquisition and management of grocery store anchored retail centers. As part of our own due diligence process, we always calculate gross potential rent. If you are an Accredited Investor and would like to learn more about our current opportunities, click here.
What is Gross Potential Rent?
In the simplest terms, a commercial real estate property’s gross potential rent is the total amount of rental income it could produce, assuming that all units are rented (no vacancy/full occupancy) at market rates and all tenants are paying on time. To illustrate this point, an example is helpful.
Suppose that an investor purchases a grocery anchored retail center with 50,000 square feet of rentable area spread over 10 units. For the sake of this example, assume that the market rent for this space is $10 PSF. So, if we assume that the property is completely full and all tenants are paying the market monthly rent amount, the Gross Potential Rent for this property is $500,000 (50,000 * $10) annually.
Why It Is ”Potential” Rent
The rent is classified as “potential” because there are two very important assumptions in the calculation.
First, the GPR calculation assumes that all of the units or square footage is rented, all of the time. Even in a successful property like one of our grocery anchored retail centers, tenants may come and go, which may result in some period of time in which a space sits vacant. When this happens, the actual rental income will be less than the potential rent.
The other major assumption in the GPR calculation is that each tenant pays their rent, on time, every month. Again, this may be an overly optimistic assumption. Even in successful properties, there may be late payments or missed payments that would cause the actual income to be lower than the potential.
Gross Potential Rent vs. Market Rent
There is a third assumption in the GPR calculation that presumes each tenant is paying market rents. In an ideal scenario, this is the case, but the truth is that market rents are dynamic and, over the course of a multi-year lease, could have a significant variance to the actual rent paid by the tenant.
For example, suppose that a grocery store signed a 10 year lease with a rental rate of $20 per square foot and 2% annual increases. But, suppose that the market is a hot one for investment property and rents rise faster than 2%. After 5 years, the contractual rent is ~$22 PSF, but the market rent is $25 PSF. Again, this could result in a significant variance between potential rent and actual rent.
In other words, the GPR is the total amount of rental income that could be earned if all spaces are leased at the market rental rate. Contrast this with the market rent, which is the prevailing rate at any given point in an investment holding period.
Gross Potential Rent vs. Gross Potential Income
Although the terms sound very similar, there is a distinct difference between Gross Potential Rent and Gross Potential Income.
Gross Potential Rent is the maximum amount of rental income that a property produces.
Gross Potential Income refers to all of the income that a property could potentially produce.
In other words, rental income is not the only type of income that a property could potentially produce. This especially true for multifamily apartment buildings that may charge additional rent for things like pet rent, vending machines, or parking. Other property types may charge for things like late fees or antenna rental for extra tall buildings.
Why Understanding Gross Potential Rent Is Important For Investors
Net Operating Income is calculated as a property’s income less operating expenses. So, for example, a property’s gross potential rent plus all other sources of income would equal Gross Potential Income.
From this number, operating expenses/operating costs like property taxes, property management, insurance, and maintenance are subtracted to arrive at NOI.
NOI is the key number used in property valuation. The market value for a given commercial property is calculated as NOI divided by the property’s cap rate. Among all of the other metrics that real estate investors must understand, this one may be the most important.
Gross Potential Rent in Real Estate Syndication Investments
Again, there are dozens of metrics that real estate investors must understand in the evaluation of a potential investment. For example, things like purchase price, effective gross income (EGI), gross rental income, gross potential rent, net leases, and gross rent multiplier. They are all important and there may be slight nuances in how they are all calculated.
For individual investors, it can be tricky and time consuming to understand the nuances between all of these numbers and what they stand for. Fortunately, there is an option that leaves much of this hard work up to professional real estate firms who evaluate all of these metrics in an attempt to determine the potential profitability of an investment.
For individual real estate investors who do not have the experience, expertise, or time to complete a full evaluation of every potential investment, working with a syndicator or private equity firm can be an excellent option that provides all of the benefits of a commercial real estate investment but not the hassle of trying to find, evaluate, finance, or manage properties.
Summary of Gross Potential Rent
Gross potential rent is a financial metric used to evaluate the amount of income that a property could potentially produce.
Gross Potential Rent is calculated as the amount of rental income a property could produce assuming all units were rented at market rates, and all tenants paid their rent on time each month.
Gross Potential Rent is often confused for other income metrics like Gross Potential Income or Effective Gross Income, so it is important that investors understand the differences.
Gross Potential Rent is also an important input in the calculation of Net Operating Income, which is used to determine property value for commercial assets.
Calculating Gross Potential Rent, along with a host of other financial metrics is a time consuming task that requires deep expertise. For this reason, some investors may prefer to work with a professional real estate firm, like a private equity shop, to handle all of the hard work of finding, analyzing, financing and managing a commercial real estate property.
Interested In Learning More?
First National Realty Partners is one of the country’s leading private equity commercial real estate investment firms. We utilize our liquidity and decades of experience to find multi-tenanted, world-class investment opportunities for our partners.
If you are an Accredited Investor and want to learn more about our investment opportunities, contact us at (800) 605-4966 or firstname.lastname@example.org for more information.