Vacancy rates are a big factor when it comes to selecting an investment property. It provides information on how many properties are vacant and for how long, but it can also shed light on how well the property is being managed.
If purchasing investment property, understanding the property’s vacancy rate may provide insight into the desirability of the property, especially when compared to other area vacancy rates. Understanding the vacancy rate formula may shed light on whether or not a property is a wise investment.
What Is Rental Vacancy Rate?
Vacancy rates of an investment property are the unrealized income of the property – the income lost as a result of the property not being rented. Most often, it is expressed in a percentage that shows the number of unrented real estate units for the specific property holding that remain unrented. Understanding the rental vacancy rate is one component of the bigger picture of whether or not an investor should consider the purchase.
Why Vacancy Rates Matter
Vacancy rates matter because they provide information about the unrealized rental income the property has, but they also uncover information about the management of the property. For example, suppose a property has a consistently high vacancy rate in a market that has limited available rental properties. In that case, that could indicate the property is less desirable or poorly managed in some way. In this situation, the investor may need to take significant steps to improve the property to rent it.
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5 Factors That Impact Rental Vacancy Rates
Various factors impact rental vacancy rates, including:
- The economic conditions in the region – high unemployment could be a factor, for example, as people move to be closer to jobs and opportunities
- Lack of demand – some properties may have a lack of demand due to the type of property, such as size or features of it that do not compete with other options
- A high level of rental competition – this is not uncommon when a number of newer developments are going in as people seek out newer properties
- Improperly set rental rates – this could be due to high turnover or periods where the competition offers better rates
- Ineffective management of the property – this is not uncommon, especially if the property continues to struggle with vacancy rates, but the conditions of the units are good overall
How to Calculate Vacancy Rates
There are several types of vacancy rates to consider. Here’s a closer look.
Physical vacancy rate
It is possible to calculate occupancy rates. The physical vacancy rate formula is:
- # of days the property is vacant divided by the # of days it is available equals the vacancy rate
Real estate investors should understand how to apply this formula to the property they are considering purchasing as one of the core considerations before choosing an investment. Vacancy rate not only provides information about property condition and demand, but it also can help investors determine how many of a larger, multi-unique property’s units need to be rented to break even or produce the desired rental income.
The physical vacancy rate formula is the most commonly used for single-family properties. Here is an example.
Let’s say a rental property, a small single-family home, has been rented for 60 days by a tenant, but that tenant is moving out. The next tenant is available, but not until a few months later, and will rent for about 100 days of the year. In this situation, add 60 and 100 to get 160 days that the property is rented and then divide that figure by the number of days it was available – 365. In this case, the vacancy rate is 43%.
Economic vacancy rate
Another figure to consider is the economic vacancy rate formula, which provides insight into how much rental income is being collected compared to what could be earned if the property was upgraded, for example. This formula is:
Lost rental income divided by gross potential income equals economic vacancy rate.
Here’s an example.
The investor learns that area properties like their own are being rented at $2,000 per month on average, but their property is only netting $1,500 per month right now. That’s a $500 gap per month of loss. The vacancy rate formula requires determining the lost rental income in this situation.
The first step is to determine the lost rental income first – which in this case is $500 multiplied by 12 months, or $6,000. Then, determine what the rent could have been – $2,000 multiplied by 12 months equals $24,000. The next step is to divide 6,000 by 24,000, which equals 25%.
What Is the Average Vacancy Rate?
It is not possible to provide an average vacancy rate that applies to all areas because this is a very specific formula related to a local region. What’s more valuable is using the vacancy rate of a potential investment property and comparing it to others in the area.
The Federal Reserve indicates that the rental vacancy rate for the country in 2022 was 5.8%. That figure really does not provide insight, though, into the overall localized information needed to make investment decisions.
Low vs High Vacancy Rates
What is a good vacancy rate? Take a closer look at what high vs low actually means.
When there is a high physical vacancy rate, that indicates there is a concern with the property in some way, such as poor advertising or that the rent set is too high for the market competition. If the property is in need of work to upgrade it to match the area, that’s also a key reason physical vacancy rates could be higher.
Low physical vacancy rates mean the property is doing better with rentals than the entire market. This could be because the property is well managed and a desirable place to live, or it could be because the property’s rents are lower than the competition.
A high economic vacancy rate indicates it may be time to consider renegotiating rates with the current tenants, assuming the property is in the same type of condition as comparable properties in the area.
A low economic vacancy rate provides insight that the property is well managed and may be more profitable than other properties in the area as a result.
How Vacancy Rates Affect Renting Out Your Property
Vacancy rates may impact renting out a property depending on the overall cause. If vacancy rates are high and that is due to significant competition in the market that stands out beyond the current property, that could make it harder to rent.
How to Reduce Your Rental Property Vacancy Rates: 5 Tips
Lowering vacancy rates is something to work towards for most investors to avoid vacancy loss. What is vacancy loss? In short, it occurs when there is a loss of income due to the property not being rented. Some ways to minimize the vacancy rate include:
- Improve applicant screening to reduce turnover of tenants
- Market properties better, including online and through other methods to increase visibility
- Improve the properties appearance, especially curb appeal
- Update and modernize units that are no longer competitive with properties in the area
- Make repairs as needed with significant upgrades during tenant turns
Wrapping Things Up
Understanding vacancy rates is critical for all investors and investment owners. This is an ongoing figure to monitor over the lifetime of ownership.