Vacancy rate assumptions for rental properties

What the vacancy rate means

Gross potential rent is the rent you would collect if the property were full every day of the year. The vacancy rate is the share of that you expect to lose. Subtract the loss and you have collected rent, which is the starting point for net operating income.

Most calculators, including ours, call the input "vacancy and credit loss." Credit loss is rent a tenant owes but never pays. It is real money lost, so it belongs in the same allowance.

The vacancy rate here is an average over years, not a forecast for one year. One year you may lose nothing. The next, a tenant leaves and the unit sits empty for six weeks while you paint and find someone new. The rate spreads those gaps across the years you own the place.

Turning time into a percent

It is easier to think in empty weeks than in percents. Convert like this:

• Two empty weeks a year: 14 / 365 = 3.8%
• One empty month a year: 1 / 12 = 8.33%
• Six empty weeks a year: 42 / 365 = 11.5%

Or think in tenant turnover. If a typical tenant stays 24 months and the unit then sits empty for 1 month, that is 1 empty month in every 25: 1 / 25 = 4.0%. If tenants stay only 12 months with the same 1-month gap, it is 1 / 13 = 7.7%. Shorter stays raise the rate even when each gap is the same length.

Then add a little for credit loss if you expect any. Some investors add 1% or so. Whatever you pick, write down why.

Worked example

Made-up numbers for a single-family rental. They are not the calculator's starting numbers. Rent is $2,000 a month, so gross potential rent is $2,000 x 12 = $24,000 a year. To keep the arithmetic easy to follow, operating costs are a flat $9,000 a year and the loan payment is $1,000 a month, or $12,000 a year.

• 3% vacancy: loss $24,000 x 3% = $720. Cash flow $3,000 - $720 = $2,280 a year
• 5% vacancy: loss $1,200. Cash flow $1,800 a year
• 8% vacancy: loss $1,920. Cash flow $1,080 a year
• 10% vacancy: loss $2,400. Cash flow $600 a year

Moving from 3% to 10% cuts this property's cash flow by almost three quarters, from $2,280 to $600. The rent and the costs did not change. Only the assumption did.

A real analysis has costs that move with collected rent, such as management at a percent of what you collect. Those fall slightly when vacancy rises, so the real swing is a bit smaller. The calculator handles that for you.

Break-even vacancy

Turn the question around: how much vacancy can the property take before cash flow hits zero?

In the example, cash flow with no vacancy at all is $3,000. So break-even vacancy is $3,000 / $24,000 = 12.5%. That is 12.5% x 12 = 1.5 months of empty time a year. One long turnover with repairs could use all of it.

This is a useful way to judge risk. A deal with a break-even vacancy of 20% has room for a bad year. A deal that breaks even at 4% does not. The same idea for nightly rentals is in short-term rental break-even occupancy.

Picking your number

• Ask two or three local property managers how long units like this sit empty and how long tenants stay.
• Look at how long similar rental listings stay up before they are taken down.
• Use public rental vacancy data for your area as a cross-check, knowing it covers all rentals, not your street or your type of unit.
• If you own rentals already, use your own history.
• Seasonal markets, student areas and high-end units often see longer gaps. Price a unit above the market and it will sit longer.

When in doubt, run the deal at two or three rates. If it only works at the lowest one, it is fragile.

What vacancy does not cover

The vacancy rate is lost rent only. A turnover also costs money: cleaning, paint, small repairs, a leasing fee if a manager finds the tenant, and utilities while the unit is empty. Put those in repairs, management and utilities, not in vacancy. And keep a reserve for the big items. See CapEx reserves for rental properties.

FAQ

What vacancy rate should I use?

Use a rate based on how long similar units in your area sit empty and how often tenants move. Local property managers are a good source. If you have no data, test a few rates and see which ones still work.

How do I turn empty weeks into a vacancy rate?

Divide the expected empty time by the full year. One empty month a year is 1 divided by 12, or 8.33%. Two empty weeks a year is 14 divided by 365, or about 3.8%.

What is credit loss?

Rent that is owed but never paid. Many investors fold it into the vacancy allowance, which is why calculators often say vacancy and credit loss.

Should I use 0% vacancy if the unit is rented now?

No. A current lease ends at some point, and the gap before the next tenant is real. Plan for it over the years you expect to own the property.