Economic Vacancy
The difference between the gross potential rent at a property and the actual rent collected. An example of this would be an apartment complex with a 2-week free rent period for new tenants and a 50% annual tenant turnover. Assuming the property was 100% occupied (i.e. a physical vacancy of 0%), there would still be an economic vacancy of 1.85% (2/54 weeks x 50%) whereby the property owner would only receive 98.15% of his annual cash flow.
Putting “Economic Vacancy” in Context
Scenario Overview:
Alpine Ridge Partners, a real estate private equity firm, recently acquired Highpoint Flats Apartments, a 150-unit, market-rate multifamily property in Denver, Colorado. This acquisition fits within the firm’s Core-Plus strategy, targeting stabilized properties with minor value-add opportunities in growing markets. Highpoint Flats is well-located and typically enjoys high occupancy, but Alpine Ridge faces challenges typical of the Denver rental market, including tenant turnover and the offering of rental concessions like two weeks of free rent.
Economic Vacancy at Highpoint Flats:
Though the property operates at 95% physical occupancy, the economic vacancy is higher due to the two-week free rent concession given to new tenants and an annual turnover rate of 40%. Additionally, apartment units sit vacant for an average of 10 days during tenant turnover for cleaning and preparation.
To calculate the economic vacancy, let’s break down the components:
- Free Rent Concession:
Highpoint Flats offers two weeks of free rent to new tenants as an incentive. Assuming a 12-month lease, this free rent reduces the property’s gross potential rent because the property is only collecting 50 out of 52 weeks of rent from each new lease.
For tenants receiving the concession, that equates to approximately 3.85% of lost rent annually (2 weeks/52 weeks). - Turnover Downtime:
With 40% annual turnover and a 10-day unit prep period for each move-out, Highpoint Flats will lose some rent from the downtime during these tenant turnovers. This results in additional economic vacancy, as the property will not be collecting rent during those 10 days.
Here’s the calculation for turnover downtime:
Turnover vacancy = (10 days / 365 days) × 40% = 1.10%
Total Economic Vacancy Calculation:
The total economic vacancy is the combination of the rent lost due to the two-week free rent concession and the turnover downtime:
Economic Vacancy = 3.85% (concession) + 1.10% (turnover downtime) = 4.95%
So, while Highpoint Flats maintains a healthy physical occupancy of 95%, the actual economic occupancy (the portion of rent collected relative to the potential rent) is lower due to these factors.
In this case, Alpine Ridge is collecting 95% physical occupancy minus 4.95% economic vacancy, meaning the property is effectively collecting rent on 90.05% of its total potential rent.
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