How To Calculate Rental Vacancy and Credit Loss in Real Estate

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Failure to anticipate the loss of rental revenue due to vacant units and non-payment of rent will lead to lost profitability in your real estate investments. Whether you're a landlord with one rental or a real estate business owner with a few multi-unit buildings, learn how to calculate and account for vacancy loss and credit loss to better understand your gross potential income and operating income.

Key Takeaways

• Vacancy loss is when a tenant moves out and you have an empty unit generating no income for a time span.
• Credit loss is when a tenant doesn't pay their rent.
• Both will impact your profits from the rental property, and could also impact borrowing opportunities with lenders.
• You can calculate the loss by understanding your net operating income and the average vacancy and credit loss rate in the area.

Rental Vacancy and Credit Loss

Whenever you're investing in a rental property, you need to take into account vacancy loss and credit loss. Vacancy loss is when a tenant moves out and you have an empty unit generating no income for a time span. Credit loss is when a tenant doesn't pay their rent. Both will impact your profits from the rental. And if you're looking for a loan to start your real estate business, a lender may also take these two items into account.

Calculating Vacancy and Credit Loss

First, you'll want to determine an expected percentage of loss due to vacancy and non-payment by checking that of comparable properties and the recent loss experienced by your own property or the one you want to buy.

Let's say last year's vacancy and credit loss from the property you want to buy was 3% of net operating income. Other comparable properties experienced an average of 4%. The average of these two is 3.5%.

Adjust your net operating income for next year by any anticipated rent increases. If you are anticipating a 5% increase in rent, and net operating income this year is \$44,000, then here's how you adjust for a rent increase:

\$44,000 x 1.05 = \$46,200

Now, calculate the expected monetary loss for next year due to vacancy and credit losses—remember, we are going to use the average of 3.5% from above:

\$46,200 (net operating income) x .035 (3.6% loss estimate) = \$1,617

You could expect to lose about \$1,617 next year due to vacancy and credit loss.

Note

A real estate professional may be able to help you find the comparable vacancy and credit losses for properties in the area.

Reducing Vacancy Losses

You'll never rent out real estate without vacancy loss, as people move, change their life goals, and just decide that they want to be somewhere else. However, vacancy loss can be reduced significantly through one or more of these approaches:

Market for the Right Tenants

If you're advertising low rent, and then you raise the rent, you're going to get some fast vacancies. You may want to advertise a special to get a good tenant into a unit, but when the lease is up they may expect another concession.

Keep a Nice Property and Market It

Keep up your units, make repairs promptly, and make sure your tenants have a nice place to live. They're more likely to renew their lease if they're happy with the property.

Maintain Excellent Tenant Service and Relations

Even if something breaks, a tenant is likely to have a good attitude about it if they report it and you promptly take care of it. Make it easy for them to tell you about problems, and then happily take care of them.

Incentive Tenants To Renew Their Lease

Calculate what it's going to cost you to clean, repaint and prepare a unit for a new tenant, and then add in marketing and application/interview expense. If a tenant is a good one and pays on time, offer them some incentive that's equal to what you would spend if they left and you just may keep them.

Do Accurate and Comprehensive Walkthroughs

When a tenant is moving in, have a detailed form and take photos of the condition of the unit. When they move out, do the same thing. Have a clear definition of normal "wear and tear" in the lease, and take any damages above that level out of their damage deposit.

Reducing Non-Payment of Rent

This is all about prevention, as you can't force someone into paying rent if they don't have it or don't want to pay it. The fact is that in most cases a tenant who is a risk for non-payment will have some past history of non-payment or credit problems.

Once you have what appears to be a viable tenant candidate, and possibly they've paid a non-refundable application fee, you pay for a credit and background check. This should give you a warning of high-risk tenants who have a risky payment history.

What is vacancy loss?

Vacancy loss is the amount of money you could lose if your rental property went unrented for a certain amount of time. It's usually expressed as a percentage, and you can calculate it by subtracting it from your potential gross income or net operating income.

What is credit loss in real estate?

If a renter or tenant does not pay their rent to you as the landlord, that's credit loss. It's the money you lose from your gross potential income. You can try to prevent credit loss in real estate by doing a background and credit check on any new tenants to see if they have a good or bad credit score and history of payments.