Before investing in a rental property, it is imperative that you learn how to calculate vacancy rate. The metric is extremely important when it comes to assessing the potential of a property investment.
Understanding the implication of the metric is essential for any real estate investor. A vacant rental property does not generate income for the property owner or landlord. When faced with long vacant periods, you will be forced to dip into your own pocket or cash reserves to cover any rental property costs. In worse cases, you will experience negative cash flow. It is important to keep a low vacancy rate to be able to generate a good return on investment.
In this article, we will show you how to calculate the vacancy rate and highlight its importance in real estate investing.
What Is Vacancy Rate?
The vacancy rate refers to the percentage of units that are vacant or unoccupied in a given property. It is essentially the opposite of the occupancy rate. When the vacancy rate and occupancy rate for a certain property are added together, the total should be 100%.
Ideally, the number of vacant units should be kept to a minimum. High vacancy rates point to low rental sales whereas the opposite indicate that the investment property is renting well. Remember that a vacant property does not generate an income.
Importance in Real Estate Investing
The vacancy rate can be a useful tool in a wide array of situations. It is used to assess the viability of several types of properties. More importantly, it is a highly effective comparison tool that can be used to analyze rental properties relative to the average rate of a location. The metric can also help investors determine several other metrics. Here is a brief overview of some of them:
- Rental income: This is one of the most consequential metrics you can determine after calculating the vacancy rate. The metric can give you an accurate estimation of the income that the property can generate. Additionally, it enables you to determine the net operating income of the investment property.
- Cash flow: This refers to the profit that the property generates after deducting expenses. Calculating cash flow requires using the net operating income. The rate of vacancy can be the difference between positive cash flow and negative cash flow.
- Cap rate: This is another metric that incorporates the net operating income. The capitalization rate is the return on investment that a property generates based on its expected income. To calculate the cap rate, you should divide the net operating income by the current property value.
- Occupancy rate: As we have stated earlier, this is the exact opposite of the vacancy rate. The result of adding the two should equal 100.
To use the metric in the most effective way possible, you should only utilize it when analyzing properties that are similar. Using it to compare different types of investment properties will invariably yield unreliable results.
In addition to vacancy rates being used to analyze the performance of a rental property, they also serve as economic indicators that are used to evaluate a housing market’s overall strength. Calculating the vacancy rate by city helps identify the top performing, as well as the low performing, housing markets across the US and point investors to the most lucrative neighborhoods.
How to Calculate Vacancy Rate
The formula for calculating the rate of vacancy is fairly straightforward. You simply multiply the number of vacant units by 100 before dividing by the total number of units. Below is a simple example that illustrates how to calculate rental vacancy rate using our given formula.
Let’s take an apartment building with 60 units, with 8 of them being unoccupied. Let’s also posit that the average rate of vacancy in the area is 5%. Using the vacancy rate calculator will give us a clear idea of how the building compares to the area’s average.
The first step is multiplying the number of unoccupied units in the building by 100:
8 x 100 = 800
The next step is dividing the result by the total number of units:
Vacancy Rate = 800/60 = 13.33%
The above investment property is not performing well since its rate of vacancy is higher than the average for its area. Therefore, the property owner should identify the causes behind it and take the necessary actions to remedy the issue.
Understanding Average Rates
While the average rate of vacancy for rental properties in the US is 7%, the rate varies from city to city. In certain markets, you’ll even notice a wide discrepancy between neighborhoods. Generally speaking, 2% to 4% is considered a decent rate for metropolitan areas. You can find a detailed breakdown of vacancy rates in each area by clicking here.
Another important thing to keep in mind is that average figures are different for various types of properties. Here are some of the average rates for different types of residential real estate.
1. Short-term rentals
These are self-contained properties that are rented for short periods of time. Since Airbnb occupancy rates are not consistent, the vacancy rate of short-term rentals is predictably high. The average rate is around 30%.
2. Vacation rental properties
These are short-term rentals that people use for vacations. Due to their seasonal nature, these investment properties tend to record the highest rates of vacancy in the market. Their vacancy rate is 45%.
3. Multifamily properties
These are structures that house multiple families. They consist of two to five units. Their average rate of vacancy is 5.5%.
4. Single-family properties
This refers to stand-alone structures that accommodate one family. They consist of a single unit. Their vacancy rate is 5%.
5. Apartment buildings
This refers to apartment complexes that consist of five units or more. They typically boast a very high tenant retention rate. Their average rate of vacancy is 4.7%.
In the absence of national housing data, you should also learn how to calculate vacancy rate for rental property in order to find the most profitable neighborhoods for real estate investing.
Sign up to Mashvisor now to get occupancy rates for different locations, as well as individual investment properties.
The Factors That Impact Vacancy
Much like average occupancy rates, vacancy rates are impacted by a number of external factors, besides the type of property. Real estate markets that are plagued by the following economic issues are more likely to have high tenant turnover.
1. A limited job market
One of the leading causes of high vacancy rates is the lack of flexibility in the job market. This is especially the case in small cities where one core employer is anchoring the local economy. The impact of this employer leaving can be disastrous. This is the main reason why real estate investors should avoid these markets.
2. A low-income workforce
A low-income workforce is not a good sign for real estate investors. The rental industry tends to suffer in markets that are short on cash. Long-term rental strategies, in particular, are difficult to implement in these conditions.
3. An over-saturated real estate market
Overbuilding can be extremely detrimental to the viability of a real estate market. Areas that are characterized by a high rate of construction end up registering a decrease in demand. It’s advisable that you invest in real estate in an area that doesn’t suffer from this saturation.
Learning how to calculate vacancy rate is an important part of investment property analysis. As a matter of fact, it is one of the few predictive analytics that gives you an accurate estimate of an investment’s profitability.
In addition to the rate of vacancy, you can also use several Mashvisor tools to evaluate investment properties. A perfect example is the rental property calculator. To learn more about this product, click here.