What Is Vacancy Rate and How Can It Effect Real Estate Investing

The vacancy rate is the percentage of units in a rental property, such as a hotel or apartment, that are occupied at a particular time.

Vacancy rates inform property owners of how their buildings are performing when compared to the area’s vacancy rate.

Vacancy rates are a result of unoccupied units ready to be rented or those units which are not currently rentable because of ignorance.

What is the vacancy rate calculation or formula?

In general, the vacancy rate is the ratio of rental units that are not rented or unoccupied versus the total number of properties.

The vacancy rate for commercial property is calculated by multiplying the number of non-rented units by 100 and dividing the same by the total number of units in the property or building.

Why should you use the vacancy rate when investing in real estate?

The vacancy rate is used to assess the viability of several types of properties such as buildings, apartments, hotels, etc.

The most important part is that it is an effective comparison tool that can be used to analyze rental properties relative to the average vacancy rate of a particular location.

Here is the overview of the importance of vacancy rate to determine the following metrics in real estate:

Rental income

The vacancy rate gives investors an accurate estimation of the income that a particular property can generate.

Additionally, it enables investors to determine the net operating income of the investment property and helps them to determine to choose the most profitable property.

Cash flow

After investing, investors must know the exact cash flow of their investment. To do that, the vacancy rate determines the profit that the property generates after deducting expenses.

Calculating the difference requires net operating income. Net operating income is calculated as follows:

Potential rental income + additional property-related income – vacancy losses and total operating expenses = net operating income

Cap rate

The cap rate is the return on investment (ROI) that a property generates based on its expected income, which is most important while considering investing.

The cap rate is calculated by dividing the net operating income by the current property value.

Occupancy rate

This metric is the exact opposite of the vacancy rate. The occupancy rate refers to the percentage of units that are occupied or rented out in a given property. The result of adding both of the rates must be equal to 100.

Vacancy rate + occupancy rate = 100

While considering an investment in rental property, it is helpful to know the area’s average vacancy rate so that investors can compare their property’s current performance.

Sometimes poorly managed and maintained properties have a higher vacancy rate than the area average. For a prospective buyer, this shows an opportunity to add value by decreasing the vacancy rate and increasing profitability.

Vacancy Rate Calculator

The formula for vacancy rate is the following:

Units that are not rented out / total units = vacancy rate percentage

For example, the company XYZ owns an apartment that has 200 units. Of those, 30 are not rented out.

Using this information and the formula mentioned above, company XYZ’s vacancy rate is the following:

30 / 200 = 15% vacancy rate

The formula for the vacancy rate of any city is the following:

Units that are not rented out in the city / total number of units in the entire city = vacancy rate percentage

How to calculate the vacancy rate for rental property investing

Multiple properties investors use a vacancy rate that interprets the number of units in real-time. Here’s how to calculate the vacancy rate of multiple rental properties:

1. Multiply the number of vacant units by 100.
2. Divide the result by the total number of units in that property.

For example, if an apartment building has 30 units with 3 vacant units, multiplying 3 * 100 gives you 300. Then divide that by 30 units for a 10% vacancy rate.

Single property investors use an averaged vacancy rate. Here’s how to calculate the vacancy rate of the single rental property:

1. Take the total time vacant in weeks or days.
2. Divide that number by the total time the unit could have been rented or occupied

For example, if a property was vacant for two weeks, divide that by the number of weeks in a year for a vacancy rate of 3.8%.

Let’s look at the economic vacancy rate because this rate is important while investing in property:

1. Take the total rent loss during the vacancy period.
2. Divide that by the total potential rent that could be accomplished in a year.

For example, if an investor collects $1,000 per month from a single property, the gross potential income would be $12,000.

If the property was vacant for 14 days, that’s 50% a month, and 50% of the monthly rate of $1,000 equals a loss of $500 a month.

Divide the amount lost by the gross potential rent, i.e., $500/$12,000 gives you a 4.2% economic vacancy rate.

With the examples above, investors can see how calculating the vacancy rate helps analyze the property and gives the investor information on how any property is performing in the current situation.

It even helps evaluate the past vacancy rates to estimate how the property has performed over the years.

The U.S. Census Bureau compiles residential vacancy rates and data quarterly. 

What is a good vacancy rate for rental property and investing?

A good vacancy rate depends on the rental market in the city where an investor is. As a general sense, 5% to 8% is considered the average.

If the property or the area has a vacancy rate of below 5%, then the market is good for the investors. If the vacancy rate is higher than 8%, you might look into ways that you can bring the rate down.

Before investing in a particular property, an investor must investigate the vacancy rate of that property versus the vacancy rate in that area.

If the vacancy rate of that property is higher than the vacancy rate of that area, then the investor should consider other property for investment.

What is the difference between the vacancy rate and the vacancy factor?

The gross income loss due to an unoccupied unit of property is known as a vacancy factor, and the vacancy rate is the ratio of rental units that are not unoccupied versus the total number of units.

The vacancy factor is calculated by dividing the loss in income by total potential gross income, and the vacancy rate is calculated by dividing the units that are not rented out by the total number of units.

How to find the market vacancy rate

Finding out the vacancy rate of a market or area can help you decide whether it is a good idea to invest and if it has the potential for long- and short-term growth.

So, how do you find the market vacancy rate? Well, there are three different approaches:

1. Property Managers

Property managers, also known as landlords, are the best approach to find the market’s vacancy rate. They know the number that any investor needs and will probably give you a more accurate picture than any other approach.

Property managers can also tell you about the streets and neighborhoods that have a higher or lower vacancy as well as other information about the location.

Speak to them about the vacancy rate and ask what they are currently experiencing and their future expectation and prediction.

Additionally, contacting them can give you the chance to talk with them in case you decide to hire one of them to look over your investment in their area.

2. Realtors

If the market you are looking at has realtors, then you can call in a favor and ask them to conduct a comparative market analysis and other statistics of local rental property.

The realtors are perfect for showing you how long properties sat before being rented, original listing prices versus rented prices, and other valuable data.

This kind of information is why having a company like America’s Housing Alliance in the nearest area can be so beneficial while being a real estate investor.

3. U.S. Census

The U.S. Census Bureau tracks the vacancy rates in the largest 75 markets in the country.

However, the data is mostly raw, and it must be downloaded to a spreadsheet to analyze it. This type of data does not dig into the smaller markets and can have an effect on vacancy rates in many cases.

No matter what the vacancy rate is in the market, the investors must ensure the vacancy rate incorporates the analysis. The vacancy rates are affected by the way an investor or property owner manages a property. 

The Bottom line

One of the biggest mistakes that any investor makes is to underestimate the importance of understanding the vacancy rate.

Investors need to understand that while it is tantalizing to use the market average when determining the vacancy rate for a property, using the wrong vacancy rate can affect the commercial and financial value of the property negatively.