Is there an optimum occupancy rate?

Question

It's common sense that a property with a high vacancy is bad. Probably the worst.

And I'm told that if a property is 100% occupied you're not charging enough.

Soooo I would assume that there is an occupancy rate that is optimal. Is 90% or 85% or maybe 95%, the magic number where you're maximizing rental rates and minimizing vacancy? Is this magical number true across all asset classes (SFR, duplexes, apartments)?

Math is fun! Let's use a 4plex as an example (vacancy rates over a multiple-year period)...

4-plex A: rents are at $750 per unit, $3000 per month, $36,000 per year.

At 5% vacancy, the actual rents collected = $34,200

4-plex B: rents are at $650 per unit, $2600 per month, $31,200 per year.

At 0% vacancy, the actual rents collected = $31,200

4-plex C: rents are at $900 per unit, $3600 per month, $43,200 per year.

At 25% vacancy, the actual rents collected = $32,400

In this hypothetical example, we can increase rental rates and wait for a better high paying tenant and make more money than if we lowered the rates to minimize vacancy.  But at a certain point trying to drive rents to $900 results in an overall decrease in income due to the much higher vacancy rate.

Keep in mind this doesn't take into account the quality of tenant, the frequency of "turns" or the longevity of say.

So what do you think? What occupancy rate makes you feel like your maximizing your profit?

Dave G. · Answer

@Gregory Schwartz this is a great topic you bring up and you've portrayed it in mathematically useful terms. I believe the >95% to <100% occupancy range is optimum. I agree with the supposition that 100% occupancy reflects leaving some money on the table. And agree with the qualitative considerations you've mentioned as they start to change the equation on case by case circumstances.

I tell my prop managers to charge full market rent when placing a tenant and slightly less than market rent increases on renewal so as to not drive the departure of a good tenant. Of course this is in the red-hot Phoenix market so myself as the owner is in a position of strength right now. A different market may be a totally different story (Chicago? NYC?).

Cheers,Dave

Gregory Schwartz · Answer

@Mike Dymski completely agree. I've had a number of sellers brag of "low vacancies" but their rents are low and the tenants only stay put for 8 months at a time.

@James Hamling haha “Figures don't lie, but liars figure”. That being said I do think we need to pick out KPIs (IE stats) in our business that we use to steer the ship no matter how big or small.

Mike Dymski · Answer

Good residents at good properties at market rent don't leave if they are treated well and the place is kept up.  There is something else wrong if you have to charge below market rent to keep long-term residents.

James Hamling · Answer

@Gregory Schwartz There is also an operational component to this that is all too often missed.

If your running a good, proactive operational system you will have ample notice of a tenants end of lease/move-out date in advance, will have gone in for a pre-vacancy inspection to get ahead of things including photos (if don't have them stored which, you should) to than immediately start marketing the property for upcoming availability.

Via proactive measures like this tenancy could be at 100% despite tenant turn-over ever 24months. A 100% tenancy rate does not mean your too cheap, not at all, that's a gross over-simplification of data. As is said, there are 2 kinds of lies, damn-lies and statistics.

David M. · Answer

@Gregory Schwartz

Okay, that makes sense...

Just to throw some numbers, say you had 20 units instead of 18.  One vacancy is 5%.  That means the 95% that is rented has to at least cover the lost rent of the one.  So, if the rent is $1900, that means you need to able to steadily collect and additional $100 from the other units.  Hmmmm......

Gregory Schwartz · Answer

@David M. Thanks for that. I actually started thinking about this at a Student Housing conference where the property managers were discussing 1000+ beds. Then I thought this same concept applies to my 18 unit portfolio. I should always be looking to maximize rents and minimize vacancy. But yes I agree it would be difficult to determine the “most efficient occupancy” on a smaller sample size.

David M. · Answer

@Gregory Schwartz

Honestly, I've always taken that as a "big business" concept, say if you were running a hotel and not a residential property.  Basically, the marginal rent increase has to be enough to cover the rent lost from the percentage of vacancy.  That's tough to do with a handful of units.  Your examples above bear that out.  To have a 5% vacancy, you need to be talking about 20 units (when only one unit is vacant).  So, can the marginal increase over the other 19 units cover the loss of one rent?

Also, this concept may work when you are higher turnover where you can keep resetting the rent.  Of course, turnover also has its own overhead.  But, if you were running a hotel this makes more sense since the cleaning staff would be busy either way.  Meanwhile, guests are coming and going and you can try to adjust your room rates accordingly.  This is all basically microeconomics.

Hope that helps.  Good luck.

Is there an optimum occupancy rate?

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