Vacancy

Vacancy is the gap between what a building could collect if every unit were occupied and paying full rent, and what it actually collects. It includes physical vacancy, the days a unit sits empty between tenants, and credit loss, the rent that is owed but never paid. Lenders and appraisers usually combine the two into a single vacancy and credit loss allowance, expressed as a percentage of gross potential rent.

Some vacancy is unavoidable even in a healthy market, because units turn over and need cleaning and repair between residents. Vacancy rises when supply outruns demand, and falls when there are more households looking than homes available. In this sense a market's vacancy rate is a direct signal of the balance we discuss in Supply and Demand.

In a pro forma, vacancy is subtracted from gross potential rent to arrive at effective gross income, from which operating expenses are then deducted to reach net operating income. Our default assumption is 5% vacancy and credit loss. Assume gross potential rent of $2,580,000: the allowance is $129,000, leaving effective gross income of $2,451,000.

Vacancy affects rent because rent has to cover it. A building that needs $2,455,231 of collected revenue must set its asking rent so that 95% of potential rent equals that figure, which is why our formula divides required income by 0.95. A higher expected vacancy raises the asking rent needed to reach the same collected income, and a period of high vacancy is what pushes owners to cut rents or offer concessions, lowering the effective rent.