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’ve been unoccupied. But with more experience as a real estate investor, a property’s vacancy rate can tell you a lot about how a property is being managed.

Vacancy rate can be an especially important metric if you’re thinking about buying 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.

What are vacancy rates?

A vacancy rate is a percentage that compares how many available units in a rental property are currently unoccupied. This metric refers to an investment property’s unrealized income potential. Keep in mind that vacancy rate differs from occupancy rate, which is the percentage of rental units that are occupied.

The vacancy rate can help real estate investors decide whether to purchase a property or renovate existing rentals. For example, if an apartment complex has a high vacancy rate in a market where rental demand is on the rise, this could indicate problems with the property. Perhaps the units are outdated and require substantial upgrades, or the rental price is too high for the location.

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.

How to calculate physical vacancy rate for a single unit

Physical vacancy refers to the percentage of unoccupied units in a given property, like hotels, apartment buildings, and single- and multifamily homes. The physical vacancy rate is the metric that real estate investors will use to evaluate how well a rental property is performing. This differs from economic and market vacancy rates, which we’ll get to later on.

Vacancy rates can also help you establish how many units in your properties need to be rented in order to break even on the investment, or for the investment to become profitable.

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 example

Let’s say you’re thinking about buying 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)] = Number of days the property sat vacant

365 days − 130 days = 235 days

Now, divide that number by the days the apartment was available and multiply the final number by 100 to get the vacancy rate.

235 ? 365 = 0.64 × 100 = 64%

On its own, that percentage 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 the right information to help you more accurately calculate any potential repair and maintenance expenses.

What high physical vacancy rates can tell you

There are some insights that a high physical vacancy rate can tell you about a potential or existing rental property. These include:

• Advertising and marketing issues: A high physical vacancy rate 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.
• High rental price: A high vacancy rate could also indicate that the rent is too high for the level of accommodation provided or the property’s location. You might want to renovate the property to attract tenants willing to pay a premium rent. But if you want a more turnkey project, you might choose a property in better condition.
• Outdated units: A high physical vacancy rate could mean that units sit empty because they need basic repairs that make them unattractive to renters. You might need to do some renovations or add new amenities to bring in prospective tenants.

What low physical vacancy rates can tell you

A property that’s doing better than the wider market may raise different questions. 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 for a low physical vacancy rate might be that the rental prices 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.

How to calculate the vacancy rate for a portfolio or multiunit property

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 you have either a portfolio of four separate homes or a multiunit property, like a fourplex. We’ll use the term “unit” to refer to either type of property.

Now, let’s apply the formula and multiply the final number by 100 to get the vacancy rate:

Days vacant ∕ days available = 180 ∕ 1,230 = 0.146 × 100 = 14.6%

Your combined vacancy rate across all of your units is 14.6%.

How to calculate the economic vacancy rate

Economic vacancy measures how much rent you’re collecting compared to similar properties in your area. The economic vacancy rate tells 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 the economic vacancy 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 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.

$12,000 per year = $1,000 in lost income × 12 months

Next, calculate what you could have earned had you charged the market rate.

$30,000 = ($2,500 × 12 months)

In our example, you’ll perform the following calculation and multiply the final number by 100 to convert it to a percentage, or the economic vacancy rate.

12,000 ? 30,000 = 0.4 × 100 = 40%

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.

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 is. A low economic vacancy rate also 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.

How to calculate the market vacancy rate

Market vacancy rates refer to the average vacancy rates in your local real estate market for different types of rental properties.

Given that you need tenants to occupy 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.

Ways to find the market vacancy rate

To understand the market vacancy rate in your area, start by consulting local and county government records and offices. You may also want to speak with real estate agents and developers, and talk with neighborhood groups and homeowners associations to find out more about your chosen market. Researching online is also a great way to get started.

If you’re an experienced real estate investor, you probably already work with a real estate agent who can help you analyze the local housing market and the potential of the property you’re considering.

You might also make some phone calls to other property owners to see what they’re charging tenants for rent, how much traffic often flows through an area and what vacancy rates look like among neighboring residential and commercial buildings.

What high market vacancy rates can tell you

A high market vacancy rate is an indication that you may 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?

Essentially, you want to know if people are moving out or into a certain area. A high market vacancy rate, but one that’s going down, can indicate that people are starting to rent in a particular area. This could be a good opportunity to buy a property while the market’s still getting hot.

For that information, your real estate agent is often your best source of insight, as they’re often first to know about changes in the housing market.

What low market vacancy rates can tell you

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

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

You might also want to consider certain 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.

How vacancy rate affects other real estate metrics

Are you thinking about 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. These metrics include:

• Cash flow: A high number of vacant units doesn’t produce rental income. Income from these rentals is necessary to maintain a healthy cash flow into your real estate business.
• Net operating income (NOI): Vacancy rate can also affect your net operating income (NOI). Money from rental holdings needs to be flowing into your pocket to generate more revenue and a healthy profit.
• Capitalization (cap) rate: “Cap rate” is 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.
• Gross rent multiplier (GRM): The term gross rent multiplier (GRM) refers to a method of property valuation that investors use to evaluate investment properties. High vacancy rates naturally lower the gross income of a property.
• Return on investment (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: The higher your vacancy rate goes, the less money you bring in, and the less that you stand to make 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. Put another way, as vacancy rates decrease, occupancy rates increase.

Using rental vacancy rate for your investment property

Real estate investors may want to stay on top of their properties’ vacancy rates as they weigh and evaluate potential real estate investment decisions and their properties’ overall performance.

Choosing your real estate comps

As you go about considering potential real estate investments, you’ll want to start by assessing them against comparable properties that are similar in size, condition, age and price 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 real estate comps.

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 in your area and market.

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

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

Evaluating a potential investment

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 property types may 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, but high for one in the center of a bustling city.

Analyzing rental performance

Using calculated vacancy rates 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.

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

The bottom line

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

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