Economic Vacancy
The difference between the gross potential rent at a property and the actual rent collected. An example of this would be an apartment complex with a 2-week free rent period for new tenants and a 50% annual tenant turnover. Assuming the property was 100% occupied (i.e. a physical vacancy of 0%), there would still be an economic vacancy of 1.85% (2/54 weeks x 50%) whereby the property owner would only receive 98.15% of his annual cash flow.
Putting “Economic Vacancy” in Context
Scenario Overview:
Alpine Ridge Partners, a real estate private equity firm, recently acquired Highpoint Flats Apartments, a 150-unit, market-rate multifamily property in Denver, Colorado. This acquisition fits within the firm’s Core-Plus strategy, targeting stabilized properties with minor value-add opportunities in growing markets. Highpoint Flats is well-located and typically enjoys high occupancy, but Alpine Ridge faces challenges typical of the Denver rental market, including tenant turnover and the offering of rental concessions like two weeks of free rent.
Economic Vacancy at Highpoint Flats:
Though the property operates at 95% physical occupancy, the economic vacancy is higher due to the two-week free rent concession given to new tenants and an annual turnover rate of 40%. Additionally, apartment units sit vacant for an average of 10 days during tenant turnover for cleaning and preparation.
To calculate the economic vacancy, let’s break down the components:
- Free Rent Concession:
Highpoint Flats offers two weeks of free rent to new tenants as an incentive. Assuming a 12-month lease, this free rent reduces the property’s gross potential rent because the property is only collecting 50 out of 52 weeks of rent from each new lease.
For tenants receiving the concession, that equates to approximately 3.85% of lost rent annually (2 weeks/52 weeks). - Turnover Downtime:
With 40% annual turnover and a 10-day unit prep period for each move-out, Highpoint Flats will lose some rent from the downtime during these tenant turnovers. This results in additional economic vacancy, as the property will not be collecting rent during those 10 days.
Here’s the calculation for turnover downtime:
Turnover vacancy = (10 days / 365 days) × 40% = 1.10%
Total Economic Vacancy Calculation:
The total economic vacancy is the combination of the rent lost due to the two-week free rent concession and the turnover downtime:
Economic Vacancy = 3.85% (concession) + 1.10% (turnover downtime) = 4.95%
So, while Highpoint Flats maintains a healthy physical occupancy of 95%, the actual economic occupancy (the portion of rent collected relative to the potential rent) is lower due to these factors.
In this case, Alpine Ridge is collecting 95% physical occupancy minus 4.95% economic vacancy, meaning the property is effectively collecting rent on 90.05% of its total potential rent.
Frequently Asked Questions about Economic Vacancy in Commercial Real Estate
What is economic vacancy in real estate?
Economic vacancy is the difference between a property’s gross potential rent and the actual rent collected. It includes losses due to concessions (e.g., free rent) and downtime during tenant turnover, even if physical occupancy is high.
How is economic vacancy different from physical vacancy?
Physical vacancy measures how many units are unoccupied, while economic vacancy reflects revenue lost from concessions and turnover downtime—even if units are physically occupied.
How do rental concessions affect economic vacancy?
Concessions such as two weeks of free rent reduce collected rent. For instance, a 2-week concession on a 12-month lease equals 3.85% in lost rent (2 ÷ 52 weeks), contributing to economic vacancy.
How is turnover downtime calculated in economic vacancy?
Turnover downtime is calculated by multiplying the average days vacant per turnover by the turnover rate. At Highpoint Flats, 10 days of downtime with 40% turnover results in 1.10% vacancy (10 ÷ 365 × 40%).
What was the total economic vacancy at Highpoint Flats?
Total economic vacancy = 3.85% (free rent concession) + 1.10% (turnover downtime) = 4.95%
What is the effective rent collection rate at Highpoint Flats?
With 95% physical occupancy and 4.95% economic vacancy, Highpoint Flats effectively collects rent on 90.05% of its potential rent.
Why is understanding economic vacancy important for investors?
It helps investors assess the true income performance of a property beyond occupancy metrics. Even a fully leased property may underperform financially due to concessions and turnover-related losses.
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