How economic occupancy can maximize your rental income

To make money as a landlord, you need tenants. But maximizing your income as a landlord depends on more than just finding tenants to live on your property. It requires optimizing economic occupancy, which shows how much of your potential rental income you’re collecting. Calculating your economic occupancy can help you identify revenue leaks and improve the performance of your investment.

This article will show you how to calculate economic occupancy rates and analyze what they mean so you can maximize profitability, whether you’re buying a rental house or considering more extensive real estate investing.

How economic occupancy works

Understanding how economic occupancy works is easiest if you think about two key numbers: what your property could earn and what it actually earns.

The first number is your gross potential rent (GPR) – the maximum rental income a property could produce if it was 100% occupied with every tenant paying the full market rate. This is your perfect scenario.

The second number is your actual rent collected. In other words, it is the amount of rent your property is bringing in.

The economic occupancy is the actual rent collected as a percentage of the GPR. So, in simple terms, if the GPR is $10,000 and the actual rent collected is $9,000, the economic occupancy is 90%.

This is only one metric of the potential of a property. For instance, before investing, it’s a good idea to calculate the gross rent multiplier (GRM) as well. It’s a common indicator real estate investors use to assess a property.

Because different tenants pay different amounts, and things like vacancies and discounts enter the picture, it’s advisable to use various tools to manage your real estate portfolio.

Why economic occupancy matters

Understanding economic occupancy is not just about crunching a few numbers. It directly affects a host of important decisions.

First, it impacts cash flow. If your actual rental income collected consistently falls far below a property’s gross potential rent, it might indicate issues with how the building is managed, or underlying problems with the property itself.

Second, economic occupancy influences property valuation. Investors and lenders check income performance to assess a property’s value. A low economic occupancy may result in a lower valuation.

Third, economic occupancy shapes high-level decision-making. If a landlord sees under-market rental rates are hurting performance, they may change pricing. If turnover downtime is the issue, they may make sure that renovations are done faster or put better tenant screening in place.

Economic occupancy vs. physical occupancy

Physical occupancy measures the percentage of your rental units that are occupied. This measurement tells you how full your property is, helping you gauge demand and performance.

How do you calculate economic and physical occupancy?

Here are the basic physical and economic occupancy formulas:

Physical occupancy rate (%) = Occupied units (period) / Total rentable units (period)

Economic occupancy rate (%) = Actual rent collected (period) / Gross potential rent (period at market, 100% occupancy)

Monthly physical and economic occupancy calculation

Imagine you have a rental property with four units. Standard rent for each unit is $1,000 a month. Three units are occupied, and one is vacant this month. With 25% of the property vacant, your physical occupancy is 75%.

If all tenants are paying full market rent, the economic occupancy equals the physical occupancy. For this example, imagine that one of the tenants has a discounted rent of $800 as part of an introductory deal.

To calculate the economic occupancy, you must first add up the total rent you collect for the month.

$1,000 + $1,000 + $800 = $2,800

Next, divide the total rent collected by the total rent you could collect if all units were rented at the market rate.

$2,800 / $4,000 = 0.7 or 70% economic occupancy

Yearly physical and economic occupancy calculation

This example shows how to calculate physical and economic occupancy monthly, but the same formula can be applied to determine the yearly occupancy rates. To start, calculate your maximum yearly occupancy by multiplying the 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, one unit was vacant for 4 months.

$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 three 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 has a minimal impact on the yearly economic occupancy rate. Another factor that will reduce this rate is if a tenant stops paying rent, leaving you at risk.

Why 90% is a “good” economic occupancy rate

In many real estate markets, a 90% economic occupancy rate is considered healthy. It shows a balance between holding a robust physical occupancy and collecting near-market rents. It means a property is operating efficiently, likely with minimal vacancies and good pricing.

If a property’s economic occupancy falls far below 90%, there are common issues and solutions to look to. Let’s explore them.

Consider lowering the rent

This might sound counterintuitive. But if a property has an unacceptably high number of vacancies, it might mean the rent is too high for the units in the current market. Lowering the rent could attract enough new tenants to raise the economic occupancy rate. It’s a good idea to regularly review rents and adjust accordingly.

Your marketing may need improving

If no one knows you’re there, they can’t rent from you. If vacancies persist, it may be time to juice up your marketing. Perform market research, update descriptions, get better photos, and explore new online platforms. There have never been more ways to reach potential tenants than in the age of social media.

Ineffective or expensive incentives

Incentives like discounted rent, free months, or move-in bonuses can attract tenants, but they can also hurt your bottom line.

These strategies might boost a property’s physical occupancy, but they can reduce the overall rent collected and lower your economic occupancy rate. Be careful not to overuse these tactics and lock yourself into a situation in which tenants expect discounts and perks. It may make it more difficult to return to normal market pricing and could hurt long-term performance.

That’s not to say there isn’t a place for incentives. Used thoughtfully and sparingly, they can be a help to sustained profitability.

Tenants aren’t willing or able to pay

There are times when you are doing everything right and the issue is on the tenant’s side. There are many reasons a tenant might face real challenges that affect their ability to pay rent.

This is where an empathetic approach can often be beneficial to both you and the tenant. It may pay to work with them. Options include payment plans, temporary concessions, or just openly communicating and brainstorming solutions. These can help avoid expensive eviction proceedings and keep a good long-term tenant who’s going through a temporary setback.

The bottom line: Economic occupancy can help you make decisions

If you’re a real estate investor or landlord, economic occupancy is one of the most useful metrics you can track. It gives you a clear picture of how well your property is performing financially as well as helping you make important decisions.

It can guide you in adjusting rent, improving your marketing, or refining strategies and help you assess how your decisions impact the bottom line, valuation, and long-term profitability.

If you’re ready to move forward with buying a rental property or your own home, you can reach out to Rocket Mortgage and get preapproved for a loan today.