How to Calculate Vacancy Rate In Real Estate Investing

Overpaying on an investment property or losing rental income? Understanding vacancy rates provides the key numbers you need to make sound real estate investments.

Monitoring vacancy rates could save you thousands by avoiding bad deals or lost profits. We’ll cover the vacancy rate formula investors use to assess properties and the reasons behind vacancies, such as market trends or property characteristics.

Uncover practical strategies to boost your occupancy rate and enhance the profitability of your rental properties.

Defining vacancy rate

What exactly is a vacancy rate? Simply, it’s how often your rental is empty. No tenants mean no income, and that’s something you’ll want to keep an eye on.

Tracking vacancy rates helps landlords and property managers determine the overall health and profitability of their rental properties. A low vacancy rate suggests strong demand and steady rental income, while a high vacancy rate indicates issues with the units, location, rental rates, or overall market conditions.

In my experience as a rental property owner, monitoring vacancy rates has impacted decisions on pricing, upgrades, and acquisitions—keeping a pulse on vacancies helps maximize returns.

What is a good vacancy rate?

A good rule of thumb for rental property investors is to aim for vacancy rates under 10%. Anything higher could signal broader challenges with attracting and retaining tenants, ultimately eating into returns. Monitoring vacancy rates on a regular basis allows property owners to spot issues early and make adjustments to their rental strategies if needed.

Vacancy rates and property finances

Having a firm grasp on vacancy rates also assists with budgeting. You still have property expenses and a mortgage payment to account for, so knowing your vacancy rate helps balance the books. Tracking vacancies enables you to monitor a key metric that impacts your ability to make money in real estate investing.

Vacancy rate formulas

So, how do you calculate the vacancy rate for your property? There’s two approaches investors use:

Physical vacancy rate

• What it measures: How many of your units are sitting empty.
• Simple calculation: Divide the number of empty units by your total units.
• For example: If you have 20 units and 3 are vacant, that’s a 15% vacancy rate (3 out of 20).
• Why it’s important: It gives you a clear picture of how many units aren’t generating income, which guides your financial planning.

Economic vacancy rate

• Beyond just empty spaces: This formula is about the money you could’ve made but didn’t because of empty units or partial rents.
• How to calculate: Compare the total potential rental income to what you’re actually earning. Use the formula (Total Potential Rental Income – Actual Rental Income) ÷ Total Potential Rental Income.
• Look at these factors: Include empty units, those with partial rent payments, and any not paying rent at all.
• For example: Let’s say your property is fully occupied and should make $10,000, but you’re only earning $8,000; the economic vacancy rate is (10,000 – 8,000) ÷ 10,000 = 20%.
• The big picture: It tells you more about the financial health of your property and can guide you in tweaking your management approach.

What are typical vacancy rates?

Average vacancy rates shift with the economy and how many people need homes. It’s different everywhere and changes over time. For example, as of October 2023, the national average vacancy rate for residential rental property is approximately 6.6%.

Vacancy rates can also vary depending on the type of property. For example, single-family properties might have different vacancy rates than multi-family apartments or other commercial properties.

Factors impacting vacancy rates

Wondering what affects these rates? It’s all about jobs, supply and demand in your rental market, and how attractive your property is.

Local job market

More jobs in the area usually means fewer empty rentals. No jobs? You might see more vacancies.

To find out what is happening in your local market, you can use U.S. Bureau of Labor Statistics data. Their website lets you filter information by location, giving you a picture of what’s happening around you.

Keeping track of job numbers and future job market trends helps rental real estate investors understand the market vacancy rate and demand for rentals.

Economic downturns present a mix of challenges and opportunities. On one hand, they might lead to higher vacancy rates, which can be a concern for a real estate investor. On the other hand, they offer a chance to buy investment properties at bargain prices.

Rental market supply and demand

Beyond basic population patterns, investors need to analyze the rental market dynamics in a specific area. What is the ratio of renter households to available units, and is supply meeting overall demand?

Markets saturated with new rental construction can make it harder for landlords to fill vacancies, while areas with rising demand but stagnant rental inventory might indicate lower future vacancy rates. Rent report data can offer insights into market average rent, aiding investors in identifying locations with higher or lower investment risks.

Evaluating supply and demand trends in the rental market can help you pinpoint opportunities and measure potential risks.

Property amenities and conditions

Amenities, features, and overall condition impact your rental property’s attractiveness and vacancy rates. Properties that appear outdated, lack sought-after amenities, show considerable wear and tear, or have outstanding maintenance needs tend to experience longer vacancy periods.

Proactively investing in property upgrades and improvements is a strategic approach you can use to enhance occupancy rates and rental income potential.

Using vacancy rates in investment analysis

Vacancy rates aren’t just numbers—they’re your guide. They help you figure out if a rental property is worth buying and keep your existing investments on track. Here’s how:

Assessing potential deals

If you want to buy a rental property, vacancy rate projections can help you forecast achievable returns and decide if the property is a good investment. It’s a good idea to use vacancy rate formulas to evaluate investment properties at different vacancy levels. For instance:

• Calculate the impact using both 5% and 15% vacancy rates.
• Gives you a realistic view of different rental vacancy rate scenarios with varying market conditions, from weak to strong demand.
• Compare the vacancy rate of similar properties in your area to gauge the current market.

Incorporating these occupancy figures into your pro forma analysis helps avoid overestimating income. It also guides real estate investors in deciding the right offer price to meet their desired returns.

Benchmarking ongoing performance

Investors should regularly track both physical and economic vacancy rates to meet their property income goals. Comparing these rates with past periods and similar local properties helps you to benchmark performance. Look for any increases above expected levels so that you can fix issues, preventing substantial losses in revenue and returns.

Strategies for minimizing vacancy rates

Nobody likes empty rentals. The trick is setting the right rent, marketing smart, and keeping your property in shape.

• Set asking rent at the right levels. Research market rents and factor in unit sizes, amenities, and conditions.
• Create a marketing strategy for your property that includes advertising vacancies on listing sites, social channels, yard signs, and property flyers. The more exposure, the better when competing for quality applicants.
• Keep your rental property well-maintained and updated, which signals responsible ownership and management and creates strong first impressions.
• Vet all potential tenants with credit checks, employment verification, and background screening. It takes more effort upfront but avoids major issues later.
• Stay proactive in retaining good tenants, especially if demand is low. Offer renewal discounts or other incentives months before existing leases end for tenants to commit.
• Get a head start on unit turns between occupants. Inspect early and schedule contractor work so new renters can move in quickly, minimizing lost rental days.
• Build a waitlist of pre-approved tenants, so you have applicants ready to go when vacancies become available. It shortens the time it takes to fill empty units, preventing dips in rental property income.
• If you have multifamily properties, work to foster community among your tenants, for example by periodically arranging casual community events. Strong connections between residents can lead to tenant referrals. I once had a 7-plex with a long waitlist purely through word-of-mouth referrals, as the sense of community kept tenants happy.

Impact on other real estate investing metrics

While vacancy rate analysis provides an isolated snapshot of occupancy patterns, it directly impacts other rental property metrics real estate investors track. Two examples are net operating income (NOI) and capitalization rate (CAP rate).

Effect on net operating income (NOI)

Net operating income (NOI) is a metric that reflects a rental property’s profitability after you have paid all expenses. The NOI formula is:

NOI = Gross Rental Income – Operating Expenses

Gross rental income represents all money collected from tenants, factoring in any vacancy losses. Operating expenses include costs like property taxes, insurance, maintenance, utilities, and property management fees.

Lost income from vacant units lowers gross rental income, so higher vacancy rates reduce NOI.

For example:

Consider a duplex with $24,000 in potential annual rental income at full 100% occupancy. The investor budgets for 5% vacancy, so expects to collect $22,800 annually. With $8,000 in annual operating expenses, the originally budgeted NOI was $14,800 ($22,800 gross income – $8,000 expenses).

But, an unexpected rise in vacancy rate to 15% leads to a $3,600 shortfall in collected rents, bringing gross annual income down to $20,400 and the NOI drops to $12,400.

Including rental vacancy rates into your analysis helps you clearly see your property’s NOI potential. Even small shifts in occupancy rates can greatly impact your bottom line.

Relationship with CAP rates

Capitalization (CAP) rates compare a property’s net operating income (NOI) to its total market value. In simple terms, a higher NOI typically suggests that a property can support a higher valuation.

However, here’s the catch: when vacancy rates rise, the NOI decreases. It means that even if a property’s market value remains unchanged, a lower NOI can result in a higher cap rate and a riskier investment.

For example:

Property A has $100,000 in NOI and a $1M market value. Its cap rate is 10% ($100k NOI / $1M value).

If vacancies rise and Property A’s NOI drops to $80,000, but the $1M value holds steady, the new cap rate is 8% ($80k NOI / $1M value).

Put simply – more vacancies can mean higher cap rates but for the “wrong” reason of lower income. Investors should assess what’s driving CAP rate movement before acquiring based on this metric alone.

While investing in multifamily properties, I’ve seen cases where the seller advertises the rental property as “fully occupied” and has a higher CAP rate than similar properties. It’s a red flag that could indicate that the seller has lowered their tenant acceptance criteria to fill vacancies and present the property as fully rented. 

Be sure to look at the rent roll for tenant longevity, or you may face high turnover costs soon after acquisition. 

Final thoughts

Thinking about investing in rental property or wondering how your current one is doing? The vacancy rate is a go-to number. It’s a key metric for properties, helping you determine if a new rental property is worth buying or how to make the most of your existing investment.