Economic Vacancy Shouldn't Be the Sole Focus: Understanding the True Impact

In short, it's because gross potential rent is an arbitrary number; it's what the asking rents are on the property assuming 100% of the rents are achieved and occupied.

Seller's can market the rents of the property to whatever amount they want.

Simplified Example:

At $1,500 rent per month on a 100 unit property, gross potential rent would be $1,800,000 ($1,500 x 100 x 12).

Let's say comparable properties charge $1,300 per month. Their gross potential rent would be $1,560,000 ($1,300 x 100 x 12).

However, let's say the property at $1,500 offers a concession that other properties don't. They offer the second month in rent free. $1,500 / 12 = $125 per month rent reduction on average.

After everything is said and done, both the property that asked for $1,500 in rent and the properties that are asking $1,300 both have a similar net rental income of around $1,400,000.

Here's why total economic vacancy is less important than people think:

On the property that charged $1,300 in rent, their total economic vacancy would be 10.3% ($1,400,000 / $1,560,000).

On the property that charged $1,500 in rent, their total economic vacancy would be 22.2% (1,400,000 / $1,800,000).

The bottom line is both properties net $1,400,000 in rental income. If you look at only the difference in economic vacancy, you'd think the deal that charged $1,500 in rent is horribly operated when it may not be.

Conclusion:

I seperate out the physical vacancy, the bad debt, and other economic vacancy into three categories on my property analyzer.

A.) Physical vacancy is needed to know so that you can qualify for agency loans. This requirement is usually 90% physical occupancy and sometimes 85% on large deals around 300 units+.

B.) Bad debt will give you clues into the quality of the tenant base. It's also important to check the rent roll and see delinquency amounts as well. The seller can decide how long delinquent accounts can sit before being considered bad debt. There could be huge delinquency amounts, but little bad debt reported on the T12 financial statement.

C.) Other economic vacancy is the other things you need to do in order to get the most net rental income. To me, this holds the least weight of all the categories. Still, it can give you insights into the story of how the property is run and the response of the tenant base to the seller's decisions.

What Not To Do:

I would not advise to lump all forms of vacancy into one "Economic Vacancy" category. A concession or rental discount after asking too much in rent is not weighted the same as having a tenant in the unit who does not pay rent.