Taking Command of Vacancy

Fundamental Principle

While turnover and vacancy are inevitable, you can mitigate these costs (and even capitalize) by optimizing where, how, and to whom you rent.

Our Story

Since we began investing out-of-state, we've experienced some incredibly painful situations that forced us to evict residents, bear costly turns, and deal with extended financial vacancy. In each, we've tried to assess what opportunities now exist - and to capitalize when we can.

Bouncing Back Fast

We recently had to evict a resident after six weeks of non-payment, and the eviction cost us $8,500 once all repairs were complete. As we were already working on the home, we took the chance to upgrade appliances, retouch the kitchen, and repaint throughout - giving the property a fresh feel.

We finished the turn in just over two weeks, and in analyzing the market, realized market rent was now $200 higher than what we'd previously charged. We very intentionally chose to raise by only $150 in relisting, giving us access to a broader tenant pool.

In doing so, we identified a renter ahead of even taking listing photos, as she had lost out on a listing down the street with our Property Manager. Had we chosen to list at $1,000 ($200 increase), it would have been out of her price range - but $950 was workable. In setting a price just below the market, we identified a great resident before even listing the property.

Making an Investment

We have a recently-vacated single-family home that required some repairs, though the tenant’s deposit covered our costs. Instead of simply turning the property, we chose to take that moment to invest and spent $3,400 to give the listing new life.

In doing so, we were able to increase our rents by $150/months - so it will only take us about two years to make our money back. We could have listed a bit higher, but we chose to rent fast (vs. rent high) and give ourselves access to a larger tenant pool. We had four applications within 24 hours of listing the home - enabling us to be selective and ensure we pick great residents for the home.

Understanding Vacancy

When referencing vacancy, most investors are referring to an empty property - but there are two types of vacancy every investor needs to consider:

Physical Vacancy: The amount of time the property sits vacant

Financial / Economic Vacancy: The difference between the potential rent and the actual rent collected

Financial, or economic vacancy, is the umbrella term - and the actual vacancy cost every investor should be keeping in mind. Especially in the current era of uncertainty, financial/economic vacancy is likely on the rise - even if physical vacancy is less of an issue.

Understanding and building a plan for vacancy is critical - as you'll find that it's the single biggest profit killer. In turning a property, not only do you bear the physical vacancy expense, turnover costs can skyrocket when you've had a long-term or neglectful resident. Depending on the nature of the turn costs, you may or may not be able to charge from the security deposit - and if those costs are high, the deposit is unlikely to cover them regardless.

The most painful vacancy scenario is evictions - as you may have non-paying residents in the property for a month or two - and generally, this resident is no longer caring for your property. In most cases, you'll never see any return in pursuing that resident for damages, which means you'll bear both the turn expenses and several months of lost rents. (We'll talk more about evictions, and avoiding them, in a later blog post.)

Estimating Vacancy Expense

When evaluating a property and estimating the potential vacancy expense, you'll want to consider the type of property you're purchasing. It's a gross generalization, but in our portfolio, our smaller multi-family homes experience the most financial vacancy. Our larger, single-family homes tend to be rented by higher-income residents who have fewer challenges paying consistently.

As we've seen this pattern, we've evolved how we calculate vacancy expense when evaluating deals. When purchasing small multi-families, we estimate twice the vacancy expense as with our A-class, single-family homes.

That said, our A-class properties tend to see more turnover than those in the B/B+ range. In a market where properties are affordable, A-class tenants tend to move toward homeownership, vs. continuing to rent (unlike where we live, in the Bay Area). You're also more likely to struggle in renting your A-class listings in an economic downturn, as more residents are looking for affordability.

Choosing the Right Residents to Reduce Vacancy Expense

Before we begin this section, we need to repeat it: we're not lawyers, and you'll need to follow all appropriate legislation when screening and placing residents.

That said, we have a few cardinal rules when we look to rent our properties:

1. We don't negotiate on paying the security deposit and application fee in full. If those are not within the resident's budget, our listing is likely not a good match.
2. We don't accept residents with past evictions (this is legal, within the markets where we invest).
3. We don’t accept residents with past violent convictions. We are open to discussing individual cases for other offenses.
4. Residents must provide proof of reliable employment and monthly income of at least 3x rent.

We are staunch in those four rules, as we seek to provide well-maintained, safe homes to residents who can afford to inhabit and care for them.

That said, there are also areas where we're flexible, and have often found great residents that other landlords overlook. These have included:

1. Pet Owners: Pet owners struggle to find great homes, and once they settle in, they're less likely to move. We're also able to charge incremental pet rent and a higher security deposit in the rare case that the pet is destructive. We do need to apply the breed restrictions enforced by our insurance policy - but we can take most pets.
2. Limited Rental History: Young, or inexperienced renters, may struggle in securing a property without a rental history. We've never found this to be a problem, as we simply require a cosigner, who typically holds the resident accountable, and is liable for the rent.
3. Section 8: Some landlords shy away from residents using Section 8, as there are more loopholes and paperwork to jump through. That said, Section 8 is an incredibly reliable program - and we've had a great experience with our residents leveraging this program.
4. Woman's Shelters & Veteran's Associations: We've partnered with non-profit organizations that help to secure housing for vulnerable populations, and they guarantee the rent for us. These partnerships help us simultaneously do some good while continuing to do well.

Considering Vacancy When Relisting

When you've just experienced a painful turn, the instinct is absolutely to relist that property for the maximum rent possible. Who doesn't want to recoup that investment ASAP? We feel you - we've been there.

That said - if you break it down, and consider the dollars and cents - it won't always make sense to max out the rent.

If you choose to list at the highest rent possible:

1. You limit your audience and potential resident pool - and may have to compromise on a less qualified resident. This choice often comes back to haunt you in future vacancy and turn expense.
2. The listing will take longer to fill - and you'll have a higher vacancy expense while that property is on the market.

In determining whether additional time on the market makes sense to maximize rents, just run the numbers. We'll ask our Property Manager, "how long will it take to list at this price, vs. this price" - and since they're experts in our market - they can usually give us a pretty good idea of the trade-off we'd be making.

For example, if you can list a property at $950 and rent it three weeks sooner than if you were to list it at $1,000 - it makes sense to do it.

And if the numbers come out close, make sure to also consider the resident pool at each rent level - as quality is harder to calculate, but critical in reducing your vacancy expense.

The Silver Lining to Vacancy

When you do find yourself facing a vacant property, it's a great time to take a deep breath and consider what options you now have. At the most basic level, this is probably an opportunity to make some minimal investment in the property and raise rents. That's hard to do with a resident in place - so vacancy creates this window of opportunity to maximize your cash flow.

Before you rush into repairs and relisting, it's also the time to ask an important question: "Am I maximizing the value of this property?" Perhaps, the neighborhood has significantly appreciated since you purchased the property - and it might the right time to flip, sell, and re-deploy that capital. Alternatively, you might consider changing the listing to a short-term rental if there is a better opportunity to maximize rents.

No matter the situation - there is always an upside to vacancy. Once you've set your initial feelings aside, you can get to work - and make misfortune work for you.

Battling Vacancy Expense in a Pandemic

We certainly hope this section will feel outdated in the coming months, but as we're writing, the nation is still sheltering in place due to Covid-19. While we see the signs that states may start to re-open, we know that residents across the country have been significantly financially impacted by the shutdown.

As we considered our strategies for partnering with tenants in this time, we chose to provide a discount to tenants who paid their rent by the first of the month (rent is due on the fifth). In structuring that program, we hoped to help residents prioritize their rent as they received government assistance - as we know that most struggle to get current if they ever fall behind.

We're also working hard, alongside our PM, to bring our physical vacancy to zero. Through the use of Rently, which enables self-showing compliant with social distancing, we've been able to continue listing and filling our vacant properties. We've also been heavily utilizing Facebook Ads (shameless plug for Nick's employer) to engage potential residents as new listings become available, and we've been impressed by the applicant flow.

A Closing Thought

We know it's a scary time for real estate investors - especially those just starting to build their portfolio. If we can be of help in generating creative strategies to reduce your vacancy expense - don't hesitate to reach out.