What is a vacancy rate, why you should care, and how it can save you money

The Vacancy Rate

What it is and why you might care

Loan officers feed on it, investors look at it distrustfully, landlords hope it’s not too high and most people don’t have a clue what it is or why anyone should care. As a real estate investor, it can tell you vol- umes and it goes a long way toward de- termining the price and marketability of a property.

The Vacancy Rate is the percentage of units which are vacant in a property during the year.

The calculation is easy. First multiply the num- ber of units times 12 to get the number of what we’ll call “unit-months.” A four-plex would have three months, and a single family property 12. Then you divide the unit-months into the number of months any unit was vacant during the year to arrive at the Vacancy Rate.

Vacancy Rate= (number of vacant units per year)/ number of units x 12

In a 20-unit apartment complex, for ex- ample, that is 240 possible unit-months of vacancy per year. So if one unit was vacant for one month during the year the vacancy rate is 0.4%. If one unit is va- cant every month (hopefully a different one), the rate is 5%.

In a single family home, if it was vacant one month during the year, that would be a vacancy rate of 8.3%.

Now what you do with that percentage is multiply it by the Gross Income (the scheduled annual rents) to get the Va- cancy Allowance.

Vacancy Allowance = Vacancy Rate x Gross Income

So if the property takes in $72,000 a year and your Vacancy Rate is 5%, your Va- cancy Allowance is $3,600.

Now subtract the Vacancy Allowance from the Gross Income. In the example, you would subtract $3,600 from the $72,000 and get an Effective Gross In- come of $68,400.

Effective Gross Income= Gross Income minus Vacancy Allowance

Who Cares?

So who cares what the figure is? Unfor- tunately, too many landlords and real
estate investors don’t worry much about math and things like that, anyway. They just want to rent the property and get on with it. That attitude has a lot to do with the fact that too many of them are not as successful as they could be.

Obviously you care. The more income a property generates, the more value it has, all other things being equal.

excessive, such as over ten percent. Then you want to be sure that there aren’t a lot of hidden expenses and deferred mainte- nance. That decided, you can bring up the fact that most mortgage lenders will automatically deduct 25 percent from the gross rents. But since you are such a generous guy and will only deduct ten or 15 percent to figure the Effective Gross Income.

What Is a Good Vacancy Rate? And How Can I Use It to Make Money?

The first person who will want to know that figure is, other than you, is the mort- gage loan officer. Chances are he or she won’t credit the property with a Vacancy Rate less than five percent, though, and that’s if you’re lucky. In fact, many lend- ers automatically deduct 25 percent of the gross rents just on general under- writing principles. Somewhere, sometime a whole gaggle of underwriters got to- gether and decided that what with va- cancies and repairs and all, you really only pocket 75% of the scheduled rents anyway after you deduct vacancies, op- erating expenses and maintenance.

This fact is something you can use as a valuable tool for bargaining with a seller. Fortunately, you can use real figures, so you get a real idea of a fair sales price. But when you are bargaining with the seller on price, you can act and talk like a mortgage loan officer. First, you want to be sure that the seller’s figures are accu- rate and that the Vacancy  Rate is not excessive, such as over ten percent. Then you want to be sure that there aren’t a lot of hidden expenses and deferred maintenance. That decided, you can bring up the fact that most mortgage lenders will automatically deduct 25 percent from the gross rents. But since you are such a generous guy and will only deduct ten or 15 percent to figure the Effective Gross Income.

What Is a Good Vacancy Rate? And How Can I Use It to Make Money?

A good vacancy rate varies depending on the rental market in the city where you are. As a general rule, though, five to eight percent vacancy is an average. At that rate, there is a kind of balance in the number of available units and, all other things being equal, landlords should be able to increase rents moderately every year, but not at a rate that will put undue burden on tenants.

When vacancy rates drop below five percent the increased demand and reduced supply allow rental rates to rise faster. If your property or area has a vacancy rate of below 5 percent, the rental market is good for landlords and rents will go up. A vacancy rate higher than eight percent in a good market means you might want to look at what you can do to bring the rate down.

If you are looking at a property with a high vacancy rate for the area, it could be either good or bad. All you may need to do is spruce up, get rid of noisy, bothersome tenants, or get better managers.

But it could be because nobody wants to live in the neighborhood. Or it could be for some other reason that you have to ferret out. Regardless, figure it out, you don’t want somebody else’s trouble. A curable situation means you can probably get a great deal on the property. You have to decide. Experience and an objective attitude are the only qualities that will make the difference between money in the bank and money in the tank. Look at the vacancy rate figure distrustfully,
not just what the number is, but also why.