Actual vs. General Vacancy

[Anonymous]

Spencer,

Just wanted to better understand Actual vs. General vacancy. Are the following explanations are correct? Thank you
1. If you have “actual vacancy” within “rental revenue,” the “other income” is netted up (includes vacancy too)
2. If you have NO “actual vacancy” within “rental revenue,” the “other income” is grossed up (does not include “vacancy”) and therefore we address the vacancy issue at the “general vacancy” line
3. Therefore it’s simply, General vacancy = “Actual vacancy” lowering the “rental revenue” side + “Actual vacancy” lowering the “other income” side

[Anonymous]

Hi Quark104449,

I was wondering the same thing. Here’s what I think, and please correct me if I’m wrong:

If we were to apply Actual Vacancy (if any) into the Total Rental Revenue it would represent the loss in revenue for the vacant units’ rent only; by doing so, we would also need to apply vacancy factors when calculating other incomes including storage and parking, etc. as these will be impacted.

On the other hand, if we apply the General Vacancy line, it would consider all the loss associated with the vacant units as a combined percentage, which is the easier route.

I guess it all comes down to the specific case/project to determine which option to go with. My question is, generally for stabilized assets shouldn’t we use the more accurate one? I would think General Vacancy would apply more to the pipeline projects.

Thanks,
Allen

[Spencer Burton]

All excellent questions. Perhaps a greater explanation of how actual and general vacancy are used will help to clear up some of the confusion, and in turn answer your questions.

In most cases, you will only see “actual vacancy” in historical operating statements. In reporting what happened at the property in the reporting period, the operator will state the amount of lost rental revenue due to vacant units (i.e. downtime).

So in the case of ‘Crescent Apartments’ you’ll notice that there is Actual Vacancy (under the Rental Revenue section) reported for 2016, 2017, and the T12. Those actual vacancy amounts tell us how much potential rental revenue was lost due to vacancy.

It is thus assumed that there was likewise potential Other Income (i.e. RUBS, Other Income, and Parking Income) lost due to vacancy, but that income is embedded in the respective Other Income line items – at least that is what is most common in industry.

So to further explain this point. Let’s look at the 2016 historical operating statement for Crescent Apartments. In 2016, the property reported 5,309,488 in Potential Rental Revenue (i.e. Market Rent) with (284,036) in Actual Vacancy. That means the property experienced 5.35% vacancy that year. Total Other Income equaled 490,003 in 2016. The 5.35% vacancy is assumed to be embedded in that 490,003 number. So if we assume Other Income sources are directly fixed to occupancy and 490,003 is the total other income at 94.65% occupancy (i.e. 5.35% vacancy), we would then extrapolate that had the property been 100% occupied Total Other Income would have equaled 490,003 ÷ 94.65% = 517,700. That is called in CRE “Grossing Up” a value for vacancy.

But how do we underwrite vacancy – either for rent or for other income? In my experience everyone does it slightly different. In fact, that’s why in the case of Crescent Apartments I had the broker modeling vacancy under the Actual Vacancy line while I modeled it under ‘General Vacancy’. In terms of industry convention, neither is outside the realm of normal.

Generally speaking though, General Vacancy is a Pro Forma (not historical) line item only and is used to adjust Gross Revenue to account for the expected long-term vacancy. Remember, the Pro Forma is meant to reflect a perpetual NOI. If the property has experienced either abnormally high or abnormally low occupancy over the past few years, the General Vacancy line items allows us to smooth the underwritten vacancy to something more sustainable.

So in the case of Crescent Apartments, I hit Rental Revenue with a loss-to-lease factor but left the Actual Vacancy line as 0 (meaning grossed rental revenue up for vacancy, after accounting for a perpetual loss-to-lease). I then modeled Other Income conservatively by not grossing up Other Income line items for actual vacancy. Finally, I hit the Gross Revenue (Rental Revenue + Total Other Income) with a 5% adjustment down via the General Vacancy line to account for long-term vacancy.

Hope that helps clear up your questions!

Spencer

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