Vacancy vs Economic Vacancy

If you’re like us and have a passion for all the security and financial benefits of real estate investing, you’ve probably heard the term ‘vacancy’ when looking at a real estate investment as either a passive investor or an active investor. But many of our passive investing partners have asked us about the meaning of the term ‘economic vacancy’. In this month’s edition of The Harbor Drive Investor, we’re going to dive into the differences between vacancy, and economic vacancy. These are two very important terms you need to understand when evaluating any prospective real estate investment.

When we underwrite real estate investing deals or we’re in the field speaking with brokers and sellers, a very common term we use on a regular basis is ‘vacancy’. Vacancy represents the number of units that are not occupied by a tenant (physically vacant). Vacancy can be presented in a few different forms and is one of the many ways to measure a property’s performance. Vacancy most commonly is given in either a percentage form or in a dollar amount and can be measured across many different timelines ranging from current (today’s vacancy only) to annually (the past 12 months of vacancy) and even longer. This is an important measure and can give an investor a good idea of a property’s performance as well as identify potential opportunities or risks (i.e. is the subject property’s vacancy higher, lower, or the same as the market average vacancy). Occasionally we come across opportunities with very low vacancy which can sometimes be an indication of below market rents (i.e. the landlord keeps rents low intentionally to maintain high occupancy). These can be great opportunities to increase investor cash-flow and property value. This also means that extra income can be anticipated as well.

Pretty straight forward right? But what is the difference between ‘vacancy’ and ‘economic vacancy’? Where vacancy only measures physically vacant units with no tenants living in them (i.e. 5 vacant units at a 100 unit apartment community equals 5% vacancy), economic vacancy on the other hand accounts for physical vacancy plus all other rental losses. This is perhaps an even more important measure of a property’s performance than just vacancy because it takes into account not only the physical vacancy, but also bad debt/collection loss, rental concessions, employee rentals or discounts and any non-revenue units such as model units or down units (down units are not-rentable for one reason or another). These are important numbers to understand and consider when looking at any real estate investment opportunity. If you have a property with low vacancy but high economic vacancy, this can be problematic for your lender, your business plan, and investors if you don’t have a clear understanding of why the economic losses are high and what your plan is to fix it.