Before investing in a property, look at vacancy rates in the area to learn about market saturation and possible investment opportunities. A high vacancy rate can mean that you lose out on your investments. If you can't keep tenants in a rental property, positive cash flow projections go out the window. Read on to understand what is a vacancy rate and how it can affect investment opportunities and offer a gauge of where to buy investment properties.
What is Vacancy Rate?
A vacancy rate is the percentage of available units vacant or unoccupied at a particular time. You can apply vacancy rates to a single rental property with multiple units, such as a hotel or apartment complex, to single rental housing units, to commercial properties or to a region or market.
The vacancy rate is the opposite of the occupancy rate, which is the percentage of rental units that are occupied. High vacancy rates in an area indicate that the market is oversaturated and might not offer good investment opportunities. Within a property, a high vacancy rate indicate that a property is not renting well. Low vacancy rates can point to strong rental sales and investment opportunities.
Put another way, vacancy rates refer to an investment property’s unrealized income potential. It is typically defined in the form of a percentage of how many unrented units of any given property are currently unoccupied.
For example, a high vacancy rate in a market with high demand may indicate problems with the property that make it undesirable. To compensate for this, you may need to undertake substantial renovations before maximizing your rental income. A lower-than-average physical vacancy rate might mean that renters are being undercharged, which is also a type of unrealized income potential.
Why is the Vacancy Rate in Rental Properties Important?
Rental vacancy rates are important as they can have a major impact on a property owner's bottom line. A hotel with a 60% occupancy rate would generally perform well. A 60% vacancy rate, on the other hand, can indicate losses or cash flow issues. If you purchase an apartment in an apartment complex with a 50% housing vacancy, you'll be competing with other owners in the same complex to fill the property and may face long-term vacancies.
When extended to an area like a holiday destination or particular housing market, a low vacancy rate may indicate an investment opportunity. However, it's important to look at other factors like demand, movement and other attractive factors in the area like schools, malls or shopping centers, restaurants, parks and green spaces.
When investors calculate return on investment (ROI), it generally assumes a 100% occupancy for long-term rental properties and at least 60% occupancy for short-term rentals like Airbnbs. If you purchase a property in an area with high homeowner vacancy rates, you could have higher out-of-pocket costs until you can find a tenant. You also might have to rent at a lower rate to fill the property, further cutting into the bottom line.
What Factors Affect the Vacancy Rate in a Rental Property?
Vacancy rate is a complex subject with many unique factors influencing a particular property. Location, rent prices, property condition, marketing, competition, market rent rates, homeownership rate and regional and larger economic conditions can all affect vacancy rates.
How is a Vacancy Rate Calculated?
Calculating and applying a property’s vacancy rates is vital for real estate investors to gauge how well a potential or current investment can be expected to perform. It can also help you establish how many of your properties or housing units need to be rented to break even or for a particular investment of multiple units to become profitable.
The simplest vacancy rate is physical vacancy, which is calculated as:
Physical vacancy rate = number of days property was vacant / number of days available to rent (usually a year)
For example, if a property sat vacant for 60 days, the vacancy rate would be:
number of days property sat vacant (60) / number of days available to rent (365) = 16.43%
Generally, the higher the vacancy rate, the less desirable a property or area.
You could also calculate the economic vacancy rate, which further expresses lost potential income for both physical vacancies and charging low rent.
Economic vacancy rate = Lost rental income ∕ Gross potential income
For example, if the property's market value is $2,000 per month and it's vacant for two months, the economic vacancy would be:
Lost rental income ($4,000) ∕ Gross potential income ($24,000) = 16.66%, very similar to the previous calculation for the same scenario.
If, instead of a physical vacancy, you charge $1,500 for a property with a market value of $2,000 a month, the economic vacancy rate would be:
Lost rental income ($500*12=$6,000) ∕ Gross potential income ($24,000) = 25%,
How to Find a Market Vacancy Rate
To find a market vacancy rate to understand larger market dynamics, you should speak with real estate professionals or check U.S. census information. Here's how:
Real Estate Agents
If you’re already working with a real estate agent, they can help you analyze the local market and the potential of the property you’re considering. These professionals can give you insights into market trends and investment opportunities.
Forming long-term relationships with real estate potentials can pay off, as they’ll be on the lookout for the types of properties you’re looking for, which will save you time. They can potentially help you find under-valued properties or investment opportunities in low-vacancy areas. They may be willing to research what other owners are charging for rent and what vacancy rates look like among neighboring residential and commercial buildings.
Property Managers
Property managers can have real-time insights into many real estate properties. Speak with property managers for their professional opinions on local real estate market trends, vacancy rates and investment potential.
U.S. Census Bureau
The U.S. Census Bureau offers data on real estate vacancy rates and market trends. You can find more information, including vacancy rate reports here.
What Does a High Vacancy Rate Indicate?
A high vacancy rate may indicate an undesirable area or poorly maintained property. Whether the high vacancy rate is regional or specific can give you insights into potential investment actions. For example, you may be able to purchase a property with high vacancy rates in a region of low vacancy rates and renovate it for greater investment opportunities. A high vacancy rate can also indicate a property priced above market value. In that case, lowering rental prices may improve tenant retention.
Remember in case of high vacancy that you cannot renovate for certain location or design factors. Consider whether minor cosmetic renovations can reduce vacancy, or whether it's factors that are difficult to change like a location next to a railroad track or garbage dump or design that doesn't fit well with the neighborhood.
What Does a Low Vacancy Rate Indicate?
A low vacancy rate indicates a desirable property or neighborhood where properties are usually filled quickly and retain tenants. It can also indicate a property priced below market value, which could mean missing out on maximum income potential on the investment.
Strategies to Consider to Avoid High Vacancy Rates
If you already own rental properties or you're ready to buy your first rental property, the following strategies can reduce vacancy rates and help in tenant retention rates.
Offer Competitive Rental Rates
Research comparable properties and market trends. To attract and retain excellent tenants, offer rental rates slightly below the market average. Screen for high credit scores and explain to tenants that you're offering a lower rate because you want them to be happy and take care of the property. In the end, this can lead to a better-maintained property and satisfied tenants that remain in the property for years.
Maintain Your Property
Dilapidated or run-down properties are rarely attractive rental opportunities. Budget around 3% of your property's value each year to maintenance. Maintain the landscaping and ensure that the locks, windows, doors, HVAC system and included appliances all work well. If there are issues like leaks or something breaks, get it repaired quickly to increase the tenant's comfort.
Provide Excellent Customer Service
A tenant is your customer. Either hire a property manager or dedicate the time to managing the rental property well. Reply quickly to questions, concerns or problems. Respond to maintenance and repair requests the same day, and maintain good communication with tenants to increase their overall satisfaction.
Offer Flexible Lease Terms
Flexible lease terms can include optional renewals, flexible payment dates within the month or waive the right to check a tenant's credit score. This can open you up to more risk but can also help in tenant satisfaction and retention.
Improving Cash Flow in Rental Properties
When you want to maximize cash flow in rental properties, vacancy rates are important. You can use the information available through vacancy rates to capture new market opportunities or perform renovations that will increase property value. Taken together, vacancy rates are a tool that shows you how the market and potential tenants are moving and where you can potentially earn more by optimizing your rental offerings. Consider also reals estate investment trusts (REITs) vs. rental properties as alternative real estate investment opportunities.
Frequently Asked Questions
Are there any government regulations related to vacancy rates?
The U.S. Census Bureau reports on vacancy rates, and government policies may affect vacancy rates in certain areas, but there aren’t any regulations directly related to vacancies.
Is a high vacancy rate always a bad thing?
A high vacancy rate isn’t always a bad thing. Sometimes it presents investment opportunities. In holiday destinations, if you calculate the vacancy rate for the whole year, it may be very high. But with these properties, you might earn a year’s income in just three to four months.
What are some other common metrics used in real estate besides vacancy rates?
Other common real estate metrics include occupancy rates, rented space usage quality (RSUQ) and repair and maintenance costs, average commission per sale, sold homes inventory ratio, rent-ready costs and revenue per square foot.
About Alison Plaut
Alison Kimberly is a freelance content writer with a Sustainable MBA, uniquely qualified to help individuals and businesses achieve the triple bottom line of environmental, social, and financial profitability. She has been writing for various non-profit organizations for 15+ years. When not writing, you will find her promoting education and meditation in the developing world, or hiking and enjoying nature.