Simply investing in commercial real estate won’t bring in profit unless and until you have done your calculations well and are investing in the right place. There are different techniques and methods used for identifying the results from an investment. The success of the commercial real estate investment is directly related to the occupancy of the property. In simple words, it can be said that a property full of tenants who are paying monthly will be more likely to have a successful outcome than a situation where there will be a high number of vacant spaces or lower rentals.
Understanding the term vacancy loss and how it can affect commercial real estate investment is a must to avoid any wrong step. Therefore, the guide here will discuss commercial real estate performance metrics in detail: the vacancy loss. For sure, you will understand the importance and how it can be used during due diligence to guarantee good investment results.
Vacancy loss- What is it?
In simple terms, it can be denoted as credit loss which refers to the amount of rental income that the property owner loses when the space is unoccupied by the tenants. Generally, the term is seen as having a negative connotation. However, it can also be seen as an opportunity as it represents the amount of rental income when vacant units are entirely occupied.
Having an idea about the techniques and strategies to help fill up the vacancy rate can be highly beneficial. Doing due diligence is what will work the best. So, make sure to take proper measures.
Calculating vacancy loss
When creating a plan for a potential investment in commercial real estate property, it is essential to remember the vacancy loss. It is just an estimate, of course, when the investor is informed about the property’s current condition, which will help make better decisions. However, the investors must also see and estimate how the current situation will change in the future. Keeping this in mind, the vacant loss can be calculated easily.
Calculate vacancy rate
To start calculating the property’s vacancy rate, you need to know the measurements and other essential aspects. The calculation herein is performed based on per square foot.
For example, let’s consider a multi-family apartment that has about 10,000 vacant square feet. It is known to be a total of 100,000 square feet. This means the vacancy rate here will be 10%. Once you have successfully calculated the vacancy rate, you can move it to the second step.
Calculate vacancy loss
Herein one needs to apply the vacancy rate of the property to its growth potential income. The formula used here will be (Total SF x Rent PSF)x Vacancy rate.
Let’s consider a 100,000 SF property that has an average rent of $10 PSF. Herein the total gross income will amount to $1000000. Now when the vacancy rate is used, then the vacancy loss will sum up to $100,000. Thus, this clearly states the amount of money or the potential income lost due to the vacant space.
Estimating the potential for the vacancy
While coming up with a plan for the coming year, it is essential to estimate vacancy loss in CRE property for the future period. Also, for this, certain factors must be remembered.
General market condition
Vacancy loss is associated with the condition of the market. This means during the time of economic expansion, the loss will be quite low. While in the time of economic contraction, it will rise.
The properties that are well maintained and up to date generally have lower vacancy loss. In contrast, properties that are poorly maintained and require repairs tend to have higher vacancy losses.
During the analysis period, it is vital to estimate the lease. One must make certain assumptions about how many of the tenants will renew and stay. At the same time, how many of them will leave the space.
Market rental rates
The property’s income is directly related to the market rent and has a significant impact on the vacancy loss of the property. When there is higher market rent, there will be an increased probability that the tenants will not renew the lease and look for cheaper options. In contrast, the property with lower rentals will have a higher occupancy rate.
When creating a program, it is essential to use the best judgment. After considering all the factors mentioned above, one can estimate potential vacancy for a more extended period. Besides this, real estate investors must also remember vacancy loss figures on the income statement.
How does Eviction factors into vacancy loss?
Calculating the vacancy loss assumes that the space will not bring any income because it is vacant. But this is not the case. When the tenant is not paying the rent, it is possible that the space could remain occupied, but still, there cannot be an income from it. Therefore, it is common that the property owners will begin foreclosure proceedings for non-payment. In this case, a vacancy loss can be magnified, which is the property owner is losing money as the rent is not being paid, and they have to pay a great amount of legal and collection costs to get rid of the tenant.
Reducing vacancy loss
Vacancy loss is an excellent factor as it can reduce the amount of net operating income. Now, as commercial property valuations are based entirely on NOI, vacancy figures can result in lower property value. Thus, the owners and investors are highly incentivized to reduce it. Certain strategies can be used to minimize vacancy loss.
The property owners can consider offering an incentive to the tenants to comply with them to sign a lease. This can include a temporary free or reduced rent contribution to the internal improvement factor.
When the property is not leased at a specific rental price, the primary reason that can be helpful is a reduction in the rent to increase the odds of attracting new tenants. Therefore, it will be better to offer some rental discount or reduce the property’s rent in most cases.
In some cases, the space remains vacant because it needs repairs. When this happens, renovations might be required to attract new tenants. A renovation like a simple coat of paint or an upgrade of an HVAC system can be helpful. The goal here is to make the property more attractive to bring in potential renters and convince them to sign a lease.
The strategies undoubtedly will help gain success and increase the gross income and the property value. Thus, it can be said that the value-added investment strategy works excellent in effectively creating strong investment returns.
The real estate industry can be a lot complicated, especially when you are new. However, having a clear idea about different metrics and the strategies used to identify the potential loss or profit in the future is the key to making a successful investment. Thus, contacting a professional can be beneficial. Private Capital Investors is the company you can rely on. They have experienced professionals to help you understand things and put your money in the right place. With their support and guidance for sure, you will have a better chance of getting good returns from your investment.