What Is A Vacancy Rate And How Is It Calculated?

If you’re thinking of purchasing an investment property, it’s important to take a close look at its vacancy rates. On its face, the vacancy rate tells you how many of your properties are currently sitting vacant or how long they have been unoccupied. But with experience, a real estate investor learns what a property’s vacancy rate tells you about how the property is being managed.

Vacancy rate is an essential figure to keep in mind if you’re a real estate investor considering the purchase of a rental property. Knowing how to calculate and compare vacancy rates to local market averages won’t just help you evaluate potential investments; it can also help you get a sense of just how well your current holdings are performing.

In real estate jargon, the term “vacancy rates” refers to an investment property’s unrealized income potential. It is typically defined in the form of a percentage that illustrates how many unrented units of any given property holding are currently sitting unoccupied.

For example, a high physical vacancy rate in a market with a high amount of rental demand can indicate problems with the property that make it unattractive, thus indicating that you may need to undertake substantial renovations before maximizing your rental income. A lower-than-average physical vacancy rate might mean that tenants are being undercharged for rent.

Knowing how to calculate and apply a property’s vacancy rates is vital for real estate investors. That’s because anyone looking to dabble in investment properties needs to understand physical, economic and market vacancy rates if they wish to know how well a potential or current investment stands to perform. They can also help you establish how many of your properties need to be rented in order to break even on your investment or for it to become profitable.

Let’s take a look at the types of vacancy rates, how to calculate them and what they can tell you about a property’s earning potential.

Physical Vacancy Rate Formula

For single-family properties (or other one-unit rentals), first start by calculating the total amount of time that the property sat vacant (days, weeks, months) over a given period (typically a single year). Then divide this amount of time by the total amount of time that these properties could potentially have been rented for.

Vacancy Rate = Number of days property sat vacant∕Number of days available to rent

Physical Vacancy Rate Calculation: An Example

Let’s say you’re considering the purchase of a duplex. You plan to live in one unit and rent out the other. The last tenant’s lease ended 40 days into the year, and you have a tenant lined up for the last 90 days of the year already.

To calculate your physical vacancy rates, we first need to figure out how many days the property sat vacant. We’ll assume it was available to rent for the entire year:

365 days − [40 days(the first tenant’s lease) + 90 days (your new tenant’s lease)] = 365 days − 130 days = 235 days.

Now divide that number by the days the apartment was available: 235∕365 = 0.64. Multiply that number by 100 and you’ll get your physical vacancy rate: 64%.

On its own, that number tells you very little. But when you compare your vacancy rate to the local market’s average physical vacancy rate, you gain some insight into the questions you need to ask before you complete the purchase. Even if you’re still enthusiastic about buying the property, you’ll want good information to help you more accurately calculate your future repair and maintenance expenses.

What High Physical Vacancy Rates Can Tell You

A high physical vacancy rate, compared to what the broader local market is experiencing, can indicate problems with the property’s marketing and advertising efforts. The current owner might be relying on word of mouth, or a sign displayed in a window that fails to reach a wider pool of prospective tenants.

On the other hand, it can indicate that the rent being demanded is too high for the level of accommodation and amenities provided. If you understand that the property you’re buying is a diamond in the rough, it may be part of your business plan to fully renovate the property to attract tenants willing to pay a premium rent. If you want to take on a more turnkey project, you might choose a property in better condition.

A high physical vacancy rate could mean that units sit empty because they need basic repairs that make them unattractive to renters. Maybe the units are fine, but the building’s security doesn’t sufficiently assure prospective tenants. You’ll have to do a little detective work to figure it out but understanding the whys of a too-high vacancy rate is vital information.

What Low Physical Vacancy Rates Can Tell You

A property that’s doing better than the wider market may raise different questions to ask. You’ll want to check maintenance records carefully to make sure the current owner kept up with repair issues while maximizing profits to make the property attractive to a prospective buyer like you.

Another reason your low physical vacancy rate might be that the rents being charged are lower than what comparable units are charging. Look into whether the market will bear higher rents for the units you’re offering.

Economic vacancy measures how much rent you’re collecting compared to similar properties in your area. It will tell you how much you could make if you upgraded your facilities or renegotiated below-market rent leases. Economic vacancy can occur even when your property has a 0% physical vacancy rent.

Economic Vacancy Rate Formula

To calculate this rate, you’ll need market rates to help you calculate what you could be earning versus what you are earning. Here’s the formula:

Economic vacancy rate = Lost rental income∕Gross potential income

Vacancy Rate Calculation: An Example

Let’s assume your property is in similar condition to other rentals in your area. You learn that  other landlords charge $2,500 per month while you’re collecting rents of $1,500 per month. In other words, you’re missing out on $1,000 per month in rental income.

To apply the formula, you need to calculate your lost rental income first. In our example, that’s $12,000 per year ($1,000 in lost income ✕ 12 months).

Next, calculate what you could have earned had you charged the market rate. In our example,  you could have earned $30,000 ($2,500  ✕  12 months.)

In our example, those numbers are 12,000∕30,000 = 0.4

Multiply by 100 to convert to a percentage, and you get an economic vacancy rate of 40%

To find your economic vacancy rate, divide your lost rental income by how much you could have earned.

What High Economic Vacancy Rates Can Tell You

If you’ve gotten the property inspected and it’s in roughly the same condition as other rental properties in your area, you’ll have to take a look at renegotiating rents as the property’s current leases come to an end. Look into how and why the current owner set the rents where they are. Consider revising the current policy on setting rents.

A low economic vacancy rate tells you that the property you’re considering is close to maximizing its profits, so you’ll want to understand why it’s performing better than other properties like yours. You’ll also want to understand the amenities that drive that high performance and understand the costs of maintaining or replacing those features of the property.

What Low Economic Vacancy Rates Can Tell You

The current property owner is doing a good job at property management, or at least hired someone who was. It means you’re earning close to the building’s maximum potential as it is. Keep an eye on the neighborhood, though. The real estate market is constantly changing, and what makes a building prestigious one minute can shift quickly if standards aren’t maintained or updated to match market preferences.

Finally, market vacancy rate refers to the average vacancy rates in your area for different forms of property such as apartment buildings, condominiums and multifamily residences.

Given that you need tenants in place in your properties to keep vacancy rates low, it bears noting that multiple factors may impact your ability to attract prospective renters. Some will be within your means to control, and others will be outside of it – for example, those driven by health concerns or current economic conditions.

Sources Of Information

Start by consulting local and county government records and offices, speak with real estate agents and developers, and talk with neighborhood and homeowners associations to find out more about your chosen market. Online searches are a great way to get started.

If you’re an established investor, you probably already work with a real estate agent who can help you analyze the local market and the potential of the property you’re considering. If you’re just getting started, you may be trying to avoid agents as a cost-cutting measure. Over the long-term, however, forming these relationships can help you grow your holdings because they’ll be on the lookout for the types of properties you’re looking for, which will save you time.

It may also help to make some phone calls to other owners to see what they’re charging tenants for rents, how much traffic often flows through an area, and what vacancy rates look like amongst neighboring residential and commercial buildings. 

What High Market Vacancy Rates Can Tell You

A high market vacancy rate is an indication that you need to investigate the direction of travel in the marketplace. In other words, high compared to what? It may seem high to you, and compared to markets you’ve worked in, but how does it compare to last year’s vacancy rate in that market? Is the vacancy rate going up or down?

In other words, are people moving out or are they moving in? A high market vacancy rate, but one moving in the right direction, might signal an opportunity for buying in low and enjoying rapid appreciation in the property's value.

For that information, your real estate agent is often your best source of insight, as they can almost always feel changes in the market first, before it shows up in statistics and trends.

What Low Market Vacancy Rates Can Tell You

If the market’s vacancy rate is already low, it may indicate that an investment in rental real estate is a safe investment. Again, though, it’s important to analyze the market to determine its growth potential.

Look into the local economy. Are there new sectors in its economy that are fueling new jobs and opportunities?  Is there any prospect of public infrastructure investment that could spur new business investment? Or is the downtown looking shabby, with little vibrance or excitement in the air?

Factors that can lead to low vacancy rates include:

• The economic stability of your chosen geographic area
• Positive real estate market conditions
• A growing number of employers in the region
• Rising quality of life in your neighborhood
• Ability to quickly walk or commute to points of interest
• Easy access to public works, restaurants, shops and other amenities

Consider demographics. You can access U.S. Census Bureau population data easily through its Quickfacts tool to find out if there are more or fewer people in the market you’re considering, as well as how many of them rent versus live in an owner-occupied home. The Census Bureau also publishes information about housing vacancy and homeownership, including rental vacancy rates, that can help you learn more about market conditions.

To calculate the vacancy rate of your portfolio, or a multiunit property, all you have to do is total all the days the units were vacant and all the days the units were available to rent.

Let’s assume either a portfolio of 4 separate homes or a fourplex. We’ll use the term “unit” to refer to either type of property.

Next, simply apply the formula: Days vacant∕days available = 180∕1,230 = 0.146. Now, multiply by 100, and you’ll arrive at a combined physical vacancy rate of 14.6% across all of your units.

Considering investing in real estate? Other indicators of investment potential and performance will work in tandem with vacancy rate to help you get a better sense of how attractive an investment may be.

Cash Flow

Vacant units do not produce rental income. Income from these rentals is necessary to maintain a healthy cash flow of monies into your real estate business.

NOI

Vacancy rate can also affect your net operating income. Naturally, monies from rental holdings need to be flowing into your pocket to generate more revenue and a healthy profit.

Cap Rate

“Cap rate” is short for capitalization rate – a metric that’s used to estimate and compare potential rates of return on real estate property holdings. Rates of return are lowered when vacancy rates are high.

GRM

The term gross rent multiplier (GRM) refers to a method of property valuation that investors used to evaluate investment properties. High vacancy rates naturally lower the gross income of a property.

ROI

A high vacancy rate can put a real pinch on your return on investment (ROI). Unrented properties do not produce rental income and can add to your expenses as well.

Cash-On-Cash Return

As above, the higher your vacancy rate goes, the less money you bring in, and the less that you stand to be making on every investment dollar you spend. This is referred to as cash-on-cash return.

Occupancy Rate

The opposite of a vacancy rate is the occupancy rate, or the number of units currently occupied. In mathematical terms, they have an inverse relationship: as one goes up, the other goes down, or put another way, as vacancy rates decrease, occupancy rates increase.

Real estate investors would do well to evaluate vacancy rates as they weigh and evaluate potential real estate investment decisions, and properties’ overall performance. It’s important to understand vacancy rate averages for your area, property type and market so you know how long and to what extent that properties may sit empty. It’s also crucial to research how comparable properties (“comps”) in your chosen market and region tend to perform as you go about conducting financial forecasting and planning.

Choosing Your Comps

As you go about considering potential real estate investments, you’ll want to start by assessing them against comparable properties of similar size, condition, locale, age and pricing to gauge how relatively low or high a property’s vacancy rate is. Looking at nearby property listings, consulting local and county government websites, and speaking with other owners and real estate professionals in your area can help you get a better sense of vacancy rates on comparable properties.

Understanding Low Vs. High Vacancy Rates

Once you’ve got a sense of your comps, you’ll also want to get a sense of what levels of occupancy constitute low, average and high vacancy rates.

As you go about doing your research here, be sure to compare rates for different property types in your area such as:

• Single-family homes
• Multifamily homes
• Apartments
• Condominiums
• Townhouses
• Vacation rentals

No matter how attractive your properties are, real estate vacancies are a reality of the business. Using vacancy rate calculations, your goal as an investor is to get a sense of where average vacancy rates lie, how potential investments compare, and what you can do to keep vacancy rates to a minimum. Note that different types of property come with different vacancy rates attached, as do different geographic areas and neighborhoods. A vacancy rate of 15% may be reasonably low for a condominium building in a suburban area, for example, but high for one in the center of a buzzing city.

Using calculated vacancy rate figures can help you make smarter decisions about how well your real estate investments and rental properties are performing. For example, if you have purchased a vacation rental and it sits unoccupied 40% of the time, it may be a less attractive purchase than one that sits empty just 10% of the time. (Unless, in the former case, it’s located in a peak region where you can charge premium rents, such as a cottage on Martha’s Vineyard where you can charge four times the typical rent during the peak summer season.)

In general, poorly maintained and managed properties will contribute to a growing vacancy rate, while well-managed and maintained properties will contribute to a lower vacancy rate and more renters. Bearing this in mind, sometimes a short-term expense (a new paint job or various on-site upgrades) may lead to long-term gains thanks to growing renter interest and satisfaction.

Understanding vacancy rates can help you make better real estate investing decisions. What’s more, the lower that your calculated vacancy rates go, the higher that your potential investment profits stand to be.

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