Vacancy and Credit Loss in Real Estate Investing
In the rental industry and real estate investing market, vacancy and credit loss is the amount of money—or the percentage of net operating income—that is estimated to not be realized due to non-payment of rents and vacant units. This value is, generally, a percentage that is comparable to similar properties and gives the investor a good way to compare like companies. Actual experience is used to estimate the vacancy and credit loss for a given subject property. Your vacancy and credit loss will adjust your gross potential income. Businesses will list this figure on their income statements.
Potential for Vacancy and Credit Loss
When an investor purchases a rental property, the goal is, of course, to keep it fully rented every day of every year. Of course, this isn't a realistic expectation. No matter how much your tenants may love the home, at some point, they're going to move out. The time between when they move out and the new tenant begins to pay rent is vacancy with lost rental income.
How long you go without rent is going to vary based on a number of issues:
- The property condition and time to get it ready for the new tenants. Many times painting is required and sometimes repairs to the structure.
- Your marketing and advertising.
- The current market condition, demand for rentals.
Longer Leases and Vacancy Loss
Does requiring longer leases help to lower vacancy loss? It often does. That's why many landlords want a one year lease instead of six months. Frequent move-outs increases the cost of operation to the owner. However, when someone has to move for a job, they can and will break their lease, and often you only get to keep their deposit as damages. Chasing them down for more is usually a waste of time and effort.
You can reduce your vacancy losses by continuously marketing your rental homes, not just when you get notice of a move-out. At the very least, begin marketing the home three months before a lease is due to expire, even if the renter may renew. You don't know that they will renew, and getting a list of prospective tenants lined up can enable a move-in within days.
Another way to cut the time between tenants, especially when you have new ones ready, is to have your inspection results and repair materials and labor ready to spring into action. Get the painting and repairs done quickly and get that rent coming in again.
The Cost of Eviction
In real estate, credit loss is the act of someone not paying their rent. This lack of payment can be really damaging to your bottom line. When the issue becomes a problem, tenant eviction can take time to accomplish. If you do have to evict, you are not getting rent the entire time it takes to get them out of the property and get the structure ready for the next tenant. State landlord/tenant law determines the eviction procedure and timeline. These timelines will vary from state to state.
Most people are honest and will want to pay their rent in full and on time. Some may run into temporary income troubles, but there are others who will use the law to occupy a home for months without paying rent.
The best defense here is a good offense, meaning credit checks and rental references. You have a right to protect your interests within the state landlord/tenant laws. A good application process and interview, as well as references and a check of their credit history, is important. The best defense against eviction is to never let them occupy the home in the first place.
The Calculation or Estimate
If you don't have historical data, call a local property manager and ask what figures they're seeing for vacancy and credit losses across a spectrum of rental homes similar to yours. "Similar" in this case should consider rental price range, as income levels can influence credit loss and even change how often people need to move for work.
If you're having trouble getting vacancy rates, you may try a local real estate investment club. Some will have ready data, but you can often meet other investor members who will not have a problem sharing their data with you. Even if you have to guess, something in your calculation of rent should be taken into account for these variables.
It's your home, even if you're not living in it, so protect your interests and factor in vacancy and credit loss for accurate ROI.