Conversation about Vacancy being "Healthy" for an Asset

[John Acklen]

I was having a conversation the other day with a good friend of mine who is in the development and asset management world about a property I'm interested in purchasing.  The property is currently 100% occupied with several legacy tenants that are paying well below what market rents are in the area.  The landlord has never had an issue keeping it at 100% occupancy, and has actually mentioned they had a waiting list in the past for when units opened up. 

My plan is to purchase the asset and implement a few value-add strategies, such as sub-metering water, new appliance packages in the kitchens, raising all rents to market value (of course), along with some other renovations.  I mentioned to him that I was worried that by raising the legacy rents to market value (on top of billing back water/sewage), that I'd have a higher rate of vacancy while those tenant walk and while I wait to get new tenants in.  

He said something that really opened my eyes about vacancy - "A certain level of vacancy is HEALTHY for an asset, because you know you're actually getting the right amount in rent. For our assets we actually aim to have between 5-8% vacancy, because that means we're pushing the rents to the proper level." 

Maybe that's common knowledge, but it really flipped a switch in my brain.  Obviously, this isn't going to fly for smaller properties, but when you're looking at 100-200+ units, he was saying it's actually an indication of a healthy asset to have a certain level of vacancy.  

What are your guys thoughts on what a "healthy" level of vacancy is for an asset? At what level of occupancy do you believe you should begin to raise rents? 

[Thomas S.]

Obviously the present owner has 100% occupancy since he is supplementing his tenants rent.

 Many hobby landlords offer below market rents to hopefully avoid having to actually manage their properties. The excuse is that turn over is expensive/tenants stay longer when you supplement their rents. They may stay longer but in doing so you are losing money. Reality is turn overs are not expensive, they are built into your expenses and when a property is properly managed it is not expensive at all. Turn overs are part of business and turn over costs are necessary to maintain the quality of a property. When tenants turn over every 2-3 years there is no need for a extended vacancy as quick touch-up is all that is necessary. Long term tenant turn over is much more work and time resulting in vacancies. The hobby landlord that believes he is saving money by supplementing a tenants rent is actually losing more and spending more for turn overs in the long run.

Turn over as expensive only when improperly managed.