Are You Making This Critical Mistake in Your Multifamily Economic Vacancy Calculation?

Simply put, the mistake is including loss to lease into the economic vacancy.

When I first got into the multifamily industry 6 years ago, including loss to lease into economic vacancy was how it was taught. You'll even find that the most popularly used multifamily underwriters include loss to lease in economic vacancy.

So what is loss to lease?

Say you had rents at $1,100 six months ago. The lease agreements were 12 months long. Now today, your marketed rents are at $1,150. The existing leases still have 6 months remaining at the $1,100 rent. The new marketed rents minus all the existing rents outstanding is your loss to lease.

Why including loss to lease in economic vacancy presents a problem:

The problem with that is that loss to lease has much less negative impact on a deal than the economic vacancy items. A tenant not paying rent or having to pay them a concession just to move in is much more negative.

Including loss to lease in economic vacancy holds loss to lease and items like bad debt in equal weight.

Which deal would you prefer?

Property one:

Rents haven't been raise in 2 years and all rents are up to date. There is a 10% bad debt percentage where tenants are still in the property not paying rent.

Property two:

The area has experienced healthy amounts of growth and rents rose over 10%. Because of the recent rent increases, there are still many tenants with the old lease agreements at the lower rental rates. This equates to 10% loss to lease on the books. The tenant base is great and there is no bad debt outstanding.

Compare:

Even if your specialty is turning around run down units, you can tell there is a significant difference between the two properties. This example is used to illustrate that there is a significant difference between loss to lease and loss from items such as bad debt. Loss to lease needs to be separate from economic vacancy.