Landlording & Rental Properties

The Financial Threat More Catastrophic to Property Owners Than Simple Vacancy

Expertise: Mortgages & Creative Financing, Personal Development, Landlording & Rental Properties, Personal Finance, Real Estate News & Commentary, Real Estate Deal Analysis & Advice, Real Estate Investing Basics, Business Management, Commercial Real Estate
175 Articles Written
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Vacancy is a killer!

You agree with that statement, don’t you? I am sure that you do. The biggest fear amongst new investors—and those who want to be investors but are held back by fear—is vacancy. What if I can’t find tenants for that apartment?

Well, I am here to validate this fear. But it’s worse than that. I am here to tell you that while finding tenants for that apartment is a real problem, it is not the only. And perhaps not even the biggest problem.

Indeed, getting paid by those tenants is a much more real issue than simply finding someone to live in the unit.

Vacancy

Vacancy can and should be thought of in two separate subheadings: physical and economic. Unfortunately, when most people think of vacancy, most are inclined to consider physical only, and this is where a lot of people lose a lot of money.

woman with hands on face looking concerned, worried, sad, scared

Physical Vacancy

Simply put, physical vacancy juxtaposes actual physical occupancy in the unit against 100 percent occupancy. For example, if you have a single family house, the total 100 percent annual occupancy is 12 months, right? Now, if you have a vacancy for one month out of 12, then it can be said that your physical vacancy is 8.3 percent:

Vacancy = Months Vacant/100% Potential Occupancy = 1/12 = 8.3%

Economic Vacancy

Unlike physical vacancy, which operates in physical occupancy, economic vacancy deals with dollars. For example, if the rent on the above-mentioned SFR is $1,000/month, which means that annual gross potential income (GPI) is $12,000, then one missed rent payment of $1,000 constitutes 8.3 percent economic vacancy:

Economic Vacancy = Revenue Missed/100% GPI = $1,000/$12,000 = 8.3%

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Where things begin to differ is that the economic vacancy is smart enough to realize that there will be money lost elsewhere, aside from not receiving a rental payment due to physical vacancy.

Related: 12 Easy Tips to Reduce Your Vacancy Rates and Find Great Tenants

The kinds of things that economic vacancy underwrites are, for example, bad debt. If you’ve never had to write down bad debt, you haven’t been around this sport long enough.

LTL (loss to lease) is another important item. For example, if your rents need to go up 3 percent per year in order to perform in-line with the market, but you chose not to hike rents on a good tenant because you don't want to turn over the unit, then it can be said that you are accepting a loss of 3 percent relative to market rents.

This loss is represented in your bottom line as real dollars and needs to be recorded.

Related: 3 Little Known Factors to Help Minimize Vacancy Rates

Interestingly, as I alluded to previously, had you decided to hike the rent to keep up with the market, you would have run the risk of the tenant moving out, causing you to encounter physical vacancy, as well as turnover costs. So you see, there is definitely a dynamic that exists in all of this.

Conclusion

In the things that I underwrite, I often see pro-forma vacancy of 5 percent. Understand, even in the case of real 5 percent physical vacancy, it is not uncommon to expect 15 percent or more economic vacancy. It simply costs money to keep physical vacancy down at 5 percent in most markets, and those costs add up.

So, for those of you afraid of jumping into the game because of the what if I can’t find a tenant for this unit thing, you are wiser than most give you credit. You subconsciously sense that there exist dynamics that are less than apparent. Most people either don’t know this stuff or don’t want to mention it, because they are busy selling to you the notion that this game is oh-so-easy.

It is not, and good for you sensing this!

Have you experienced loss due to economic vacancy?

Weigh in with a comment below! 

Ben has been investing in multifamily residential real estate for over a decade. An expert in creative financing, he has been a guest on numerous real estate-related podcasts, including the
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    Ryan Schroeder Rental Property Investor from Saint Paul, MN
    Replied about 4 years ago
    Ben, When I saw the title of your column I assumed that the catastrophe worse than vacancy for which you would be writing would be “full occupancy but not receiving full rent” or something similar. My first couple of years in this business I had a building that on paper should have had a $40,000 annual revenue stream (30 years ago). My building was always full but what I actually received in rent on average those first two years was $20,000/year. It seemed folks were interested in living in this building but were not as interested in actually paying for it…so they would live rent free while I worked to get them vacated (as in professional tenants). What I learned that is far worse than vacancy is that of renting to the wrong tenant. What I advise new landlords is that I will leave a building empty before renting to a tenant that does not meet my background check and requirements. I’ll be money ahead over the alternative in most cases.
    Sonia Spangenberg from Manassas, VA
    Replied about 4 years ago
    Fascinating back and fourth here. My awareness of additional factors to evaluate has been increased. Very effective method of teaching the complexity of the issues. Thanks to all who have participated. Happen to have one of those Financially vacant tenants in our first property. Property mgr. is going to court this month. I have no recall of any discussion of this issue in the courses I’ve taken and in my reading in the two years I’ve been investing. Thanks for raising the discussion.
    Michael Dake Commercial Real Estate Broker from Huntsville, Alabama
    Replied about 4 years ago
    I am not an expert in statistics, but I don’t think that income figures, which include each person with an income, regardless of location, can usefully be compared with apartment rents, which are very location-specific, to draw a conclusion about the prevalence of cost-burdened tenants nationwide. There is NO nationwide housing market. There are thousands of local housing markets, each of which probably contains people with incomes and may or may not contain apartments. How do the compared statistics control for owner-occupancy (income not associated with a tenancy)? Multiple-income households? All that aside, Katie’s comment about the correct starting point for rents (being potential tenants’ incomes, versus landlord income goals) is very intriguing. I will definitely be researching that idea. It makes a lot of sense in some situations.
    David Hald from Iowa City, Iowa
    Replied over 1 year ago
    To echo previous comments, it’s disappointing to see such a lack of nuance and detail regarding something that many investors actually may be interested to know more about, regardless of their political loyalties/”millenial” status. I rely on BP for conicse and practical information about REI, and this site is a wealth of information and community. This article provides nothing practical, and is a bit confusing to see here on BP, which many of us have come to know as a refreshingly a-political voice online for REI info. BP successfully published at least one article detailing the new tax code months ago and its effects on investors, and the changes to prepare for. This was exemplary reporting, as it included no political hyperbole nor any ‘spin’ for or against. This article is out of place on BP, lacks a detailed argument, and seeks only to emotionally trigger and frighten readers of the the generic threat of “socialism”. Most of all, there is nothing useful in this article, regardless of readers’ politics. I hope BP reads the comments.