How do you account for vacancies and credit losses in a pro forma?

• A. Subtract Vacancy Loss and Credit Loss from PGI to arrive at EGI
• B. Add Vacancy Loss to EGI
• C. Subtract Debt Service from NOI to arrive at EGI
• D. Subtract Operating Expenses from PGI to arrive at EGI

Answer: (A)

Vacancies and credit losses reduce the cash actually collected, so you start with Potential Gross Income (assuming full occupancy and no bad debts) and subtract the expected losses from vacancies and uncollected rents. Doing this gives Effective Gross Income, the amount available before operating expenses. From there, you subtract Operating Expenses to get NOI, since debt service is a financing item and not part of EGI. The other options either add losses or subtract the wrong items from PGI, which doesn’t reflect the real income after vacancies and credit losses.