10% economic vacany - is it sustainable in the long term?

[Nick B.]

Hello BP,

I have reviewed many potential apartment deals marketed by different sponsors. While all of them were unique, most of them had one thing in common: they were underwritten for 10% economic vacancy (or less!) starting in the year two.

Somehow I don't feel good about this number. It may be appropriated for today's market with low physical occupancy and steadily increasing rents but that trend has to stop sometime in the future.

Here is the historic chart of economic vacancy (AKA economic loss) as reported by NAAHQ.ORG:

As you can see, 2005 and 2009 had total economic loss of over 15%. That's why I use 13-16% in my analysis. Needless to say, that a deal that looks fine at 10% EV, looks very slim at 15% EV and barely breaks even if expenses or exit cap rate is increased.

The last 3 years were within 10% threshold though and that trend may continue.

Hence my question: is 10% a "new norm" or should I throw it out and use at least 13% in my underwriting?

Thanks
Nick