In real estate, vacancy loss (sometimes called vacancy and credit loss) refers to the money that a property owner will not receive due to unfilled units or the non-payment of rent. While empty units certainly will not garner any income, property owners also must account for tenants not paying on time -- or at all.
How is vacancy loss calculated?
Annual vacancy loss is an estimate. While an experienced property owner might be able to see a vacancy trend over the years, a new property owner must come up with a conservative estimate that includes a vacancy provision to preserve their bottom line.
Just as a real estate investor must first check the comps before setting rental rates for a property, you should also do your research and find out how other similar properties are faring. This could be as simple as connecting and inquiring with a property manager, building owner, real estate agent, or another investor in your area and asking about their vacancy loss rates. Otherwise, you can calculate your expected vacancy loss using the national vacancy rate average, which is 6.6%, according to the U.S. Census Bureau.
To calculate your vacancy loss, use the following equation:
Gross income (annual) x vacancy rate = vacancy loss/100
For example, let's say your annual gross income from a rental property is $150,000. Using the average vacancy rate (we'll round up to 7% for easier math), here's how to calculate your vacancy loss:
150,000 x 7 = $1,050,000/100
At a 7% vacancy rate, your vacancy loss is $10,500.
How does eviction factor into vacancy loss?
Eviction can complicate vacancy loss. Like its name suggests, vacancy loss refers to vacant apartments with no rental income -- not full apartments with no rental income. While you can't count the apartment as a physical vacancy because someone is living in it, it might as well be vacant because there's no rental income.
While an evicted tenant still living in an apartment building might not count toward the vacancy rate, they certainly count toward vacancy loss in that your effective gross income is lowered--especially when you factor in the costs and legal fees you will incur during the eviction process. Your EGI is where you'll also want to make a conservative estimate to protect your financial interests.
Is 100% capacity a sign of success?
Property investors aim to protect their business by planning for less-than-optimal situations, which include loss of rent. So wouldn't it be considered a success if a rental property is 100% filled?
If an apartment building or other multifamily property is filled to capacity, it would seem that the owner marketed the property well and that the rent prices are set appropriately. It could also mean the rent is not high enough.
It would seem counterintuitive to set the rent so high as to turn tenants away or lead them to not renew their leases. Setting the rent low enough to keep them is playing it safe -- a little too safe. You didn't enter the real estate game because it was safe; rather, you became a property owner because you knew there was much potential reward for the amount of risk you were willing to take.
When you raise the rent, you run the risk of also raising your vacancy rate. But if you can do so and also succeed in keeping your tenants, your income will rise and continue to rise over the next few years. Eventually, you could be making as much money with vacancies as you would if you filled the whole property.
The bottom line
While filled units are a sign of a unit's marketing success, a low vacancy loss is a sign of financial success. Property owners must find the sweet spot with rental rates so as to lower vacancies and ensure that tenants pay the rent on time and in full.
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