How Economic Occupancy Can Help You Maximize Rental Income
Andrew Dehan4-minute read
November 22, 2022
If you own a rental property, you know the importance of occupancy. Your rental income is dependent on tenants paying their rent every month. If a unit is vacant or a tenant has missed rent, you’re missing out on potential income.
Rental property owners and property managers measure the efficiency of this income through economic occupancy. Read on to learn about economic occupancy, how to calculate it and what it could mean if your economic occupancy rate is low.
What Is Economic Occupancy?
Economic occupancy considers what a rental property is making against what it should be making. In well-managed buildings, this economic occupancy should be in the 90% or better range, while a ratio of less than 90% might indicate underlying management issues.
To maximize income, rental properties need to be managed. There are a couple key metrics used to measure occupancy. These are physical occupancy and economic occupancy.
What’s The Difference Between Economic And Physical Occupancy?
There’s a key difference between economic and physical occupancy. Physical occupancy is a measurement of the total income coming in. Economic occupancy takes the physical occupancy and measures it against the total possible income if a property is 100% occupied and tenants are paying the full market value in rent.
How Do You Calculate Physical And Economic Occupancy?
Say you have a rental property with 4 units. Standard rent for each unit is $1,000 a month. 3 of the units are occupied and 1 is vacant this month. With 25% of the property vacant, your physical occupancy is 75%.
If all tenants are paying the full rent, the economic occupancy is the same as the physical occupancy. But for this example, let’s say that one of the tenants has a discounted rent of $800/month as part of an introductory deal. To calculate the economic occupancy, you must first add up the 3 paying tenants’ rent:
$1,000 + $1,000 + $800 = $2,800
Next, divide the total rent collected by the total possible rent income:
$2,800 /$4,000 = 0.7 or 70% economic occupancy.
This example showcases how to calculate physical and economic occupancy on a monthly basis, but the same formula can be applied yearly. First start by calculating your maximum yearly occupancy by multiplying total maximum monthly income by 12.
$4,000 x 12 = $48,000
Then factor in your physical occupancy. For this example, we’ll say that on average, there was a vacant property for 4 months of the year.
$48,000 – ($1,000 x 4) = 44,000
$44,000 / $48,000 = 91.6% physical occupancy rate.
Next, we’ll factor in the discounted rent given to one renter. This renter received $200 off rent for 3 months, or $600 in concessions.
$44,000 – $600 = $43,400
$43,400 /$48,000 = 90.5% economic occupancy rate.
As you can see, the discount did not affect the yearly economic occupancy rate much. Another thing that could happen that would negatively impact this rate is having a tenant miss rent and having to evict.
What Does It Mean If My Economic Occupancy Is Over 90%?
Now, 90% is a rule of thumb for economic occupancy that means the property is well-run. While 100% economic occupancy is rare, it should be the goal. An economic occupancy of 90% or more means the property is well run, prices are fair and tenants are satisfied.
What Does It Mean If My Economic Occupancy Is Under 90%?
Every business, including rental properties, has bad months or periods with less income. An economic occupancy rate of less than 90% for a few months or year doesn’t spell ruin for you, but it could mean you’re missing out on some money. Here are are reasons why your occupancy can dip and what you need to do to address it.
Rents Set Too High
If multiple tenants are having trouble paying their rent, your rent could be too high. Take a close look at comparable rentals in the area, as well as your costs. Lowering your rent may mean collecting less per unit, but it may keep more units occupied.
Too Many Vacancies
Your economic occupancy rate is either going to be equal to or less than your physical occupancy rate. Too many vacancies mean your baseline occupancy rate is low and you’re not collecting the amount of rent you should be.
Vacancies happen for a variety of reasons. Tenants may feel the rent is too high or that the property needs better maintenance and security. Or it could be outside factors influencing vacancies, like an economic downturn or problems with the neighborhood.
Too Many Incentives
If you offer a discount, also known as a concession, this is going to factor into your economic occupancy rate. It’s helpful to know how these discounts will affect your economic occupancy before offering them. Gaining new tenants through a discount may outweigh a dip in your economic occupancy rate.
Tenants Aren’t Willing Or Able To Pay
You lose out on income if your tenants aren’t willing or able to pay. The best way to solve for this is to prevent it with good tenant screening. Verifying employment, checking credit scores and performing background checks is where you need to start in screening for reliable tenants.
Another reason tenants may not pay is if they feel their problems aren’t being responded to or taken seriously. If this becomes a regular occurrence, it’s a strong sign your property is not being regularly maintained. You and/or your property manager need to increase your responsiveness to tenant problems.
The Bottom Line: Economic Occupancy Can Help Measure Profitability
The key takeaway here is that ignoring economic occupancy could translate into you not making the most out of your rental property. It could also mean you’re unaware of management problems or property issues. In order to keep a rental property running at peak profitability, the building must be maintained and filled with high -tenants paying their rent on time for a long time.
Empty units mean lost revenue and evictions are even more costly. Doing the work to properly price your rental and screen tenants will help you keep your economic occupancy rate up. By understanding this rate, you can use it to help gauge your success.
Want to learn other ways you can measure profitability? Read more about key investor metrics in our Learning Center.
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