The Financial Threat More Catastrophic to Property Owners Than Simple Vacancy


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 problem than simply finding someone to live in the unit.

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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.


Physical Vacancy

Simply put, physical vacancy juxtaposes actual physical occupancy in the unit against 100% occupancy. For example, if you have a single family house, the total 100% 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%:

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 GPI (Gross Potential Income) is $12,000, then one missed rent payment of $1,000 constitutes 8.3% economic vacancy:

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

Where things begin to differ is that the economic vacancy is smart enough to realize that there will be money lost elsewhere, aside for 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%/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% 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.



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

So, for those of you afraid of jumping into the game because of what if I can’t find a tenant for this unit, 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?

Property owners: Weigh in! 

About Author

Ben Leybovich

Ben Leybovich has been investing in multifamily residential real estate since 2006. His area of expertise is creative finance. Ben works extensively with private as well as institutional financing. Ben is a licensed Realtor with YOCUM Realty in Lima, Ohio. He is also the author of Cash Flow Freedom University and creator of a cash flow analysis software CFFU Cash Flow Analyzer.


  1. “if your rents need to go up 3%/year in order to perform in-line with the market, …then it can be said that you are accepting a loss of 3% relative to market rents. ” Unless, and this is a big unless, unless market rents are greater than reasonable rents. Reasonable rent is the benchmark, not market rent. When competition keeps landlords honest, reasonable rent should be roughly equivalent to market rent, rendering the difference a moot point. The difference becomes important when the rental market operating out of sync with the wages which pay the rent. Such is the case today. Generally speaking, market rent exceeds reasonable rent when the tenant is cost-burdened as is the case with the majority of tenants nationwide. Therefore, It is not correct to consider the difference between reasonable rent and market rent a real loss that needs to be recorded.

    My cash flow analysis uses reasonable rent rather than market rent. I like to use the zip code-specific FMV rent guidelines that HUD produces annually.

    • Your right, market rent and reasonable rent are very different. However, reasonable rent is very dependent on an individual’s opinions based on perceived value, safety and overall community of the unit/home.

      Market rent is what the majority of renters in a market place have mutually agreed upon by signing leases as new units are made available at new rental rates. Just because a unit is listed at 1200 when all others are at 1000, that doesn’t mean that the market rate is 1200, for all that tells is that a renter found that to be reasonable. Multiple, similar units would need to be provided at 1200 for the 1200 to become the new market rent.

      Therefore, if as a landlord, you kept you rents at the old 1000 after multiple units are listed and RENTED at 1200, then you are experiencing loss-to-lease.

      • “…mutually agreed upon by signing leases…” The wording here is deceptive. If rent were truly mutually agreed upon, we would not have the nation-wide problem of cost-burdened tenants. Cost-burdened is defined as paying more than 30% of income towards rent. In 2014, 52% of renters nationwide were cost burdened with half of them paying more than 50% of their income towards rent. No tenant “mutually” agrees to such a situation. The NEED for a place to live compels them to sign leases. Your comment assumes that competition among landlords for tenants moderate rents, and in some places they do. Generally speaking, the competition mechanism does not work because housing is an inelastic expense.

        Reasonable rent is not nearly as subjective as you describe. I use the zip code-specific FMV rent guidelines that HUD produces annually.

        • “Mutually agreed upon” was a poor choice or words on my part. What was meant by that is that whether the tenant is cost burndened or not by rent making up 50% of their income, they still decide to sign a lease knowing this fact going in. I’m not sure how this fact would then suggest this is not the new market rate. I myself, as a landlord, have qualification standards that keep the rent at a maximum of 30% of their income, so this cost-burdened tenant would never qualify for my properties.

          I find your comment regarding a NEED for housing to be somewhat misleading in that a majority of people would rather go for what they want not need. Over-extending ourselves is the American way. PM’s willing to accept tenants knowing that they will be cost burdened doesn’t help the situation either.
          Back to the original topic of reasonable vs. market rent, we will have to agree to disagree.

        • I am not disputing that if a number of tenants sign agreements for, in your example, $1200 that $1200 is not market rent. Of course, it is market rent. The point is market rent can only be the benchmark to the extent that it is consistent with reasonable rent.

          According to a Harvard report, nationally the median asking rent on new apartments was $1,381 per month in 2015, while the typical renter earns $35,000 a year. Median rents should therefore be around $875. This has nothing to do with tenants choosing to overextend themselves.

        • Gregory Howard

          An interesting thing about using gross statistics to buoy up arguments is that they can be used to try to make unreasonable arguments seem righteous. An example of this is using an average rent of $1,381/mo and an average salary of $875/mo. without seeing he whole picture and making a grand statement based upon that. One of the things we do as mentioned by Logan in his reply is to make sure that the rent stays within the 30% of household income – note here household is important. The apartments are not being rented in a “burdened” manner when this is accounted for.

        • The point about the “gross” statistics is that they take many different data points and aggregate them. They say nothing about any specific situation. IF there were not a nationwide problem of cost-burdened tenants, the gross statistic for median rent would be $875.

          Almost all landlords stick to the upside-down policy of setting a rent and requiring tenants to make 3x more, rather than looking at the typical tenant wages for their community and making their rents one-third (as Nickerson and others recommend). Then they raise the rent regularly knowing full well that wages have been stagnant for a couple decades. Voila! A country where half the tenants are cost-burdened, including Gino’s.

  2. Ryan Schroeder

    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.

  3. Sonia Spangenberg

    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.

  4. Michael Dake

    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.

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