Vacancy rate in real estate: What is it and how does it work?

Seeing a neon “no vacancy” sign at a motel when you’re looking for a place to sleep is rarely a good feeling. If you're investing in home real estate, however, a lack of vacancies generally has a more positive connotation. In this context, vacancy rates refer to the percentage of unoccupied units in an apartment complex, office building or even a given geographic area at a given time. This percentage is one way to gauge a property’s rental performance and, since vacant units can’t generate income, vacancy rates are a key metric for property investors. Let’s take a closer look at how vacancy rates work, their importance in the real estate market and how to interpret the insights they may provide.

What is a vacancy rate?

To better understand what vacancy rates are, let’s dive into exactly how they’re calculated and their implications for homeowners and investors. If you’re familiar with occupancy rates, it may help to think of vacancy rates as their opposite. Instead of providing a ratio of rented space to the amount of space available, vacancy rates reflect the percentage of unused space in a building.

Calculating vacancy rate is relatively simple in concept. Let’s say there are 50 apartments in a complex, and five of them are empty despite being in rentable condition. Next, you divide 5/50 (the number of empty apartments vs. the total number of apartments), and then multiply the result by 100 to get a percentage. In this case, the vacancy rate is 10%.

Factors influencing vacancy rates

There are many situations that affect vacancy rates. Here are some of the most common factors that can influence the number of vacant units in your building:

• Above-market rental rates: If your rental units are priced higher than others in the area, you might have more time between tenants, leading to a higher vacancy rate.
• Unit turnover time: While it’s possible to ready a unit for new tenants in as little as 24-48 hours, it’s not uncommon for turnover times to be higher as necessary repairs are made, which may influence vacancy rates.
• Renovations: Upgrading your rental units, while often a positive investment in the long run, could contribute to a building’s vacancy rate.
• Location: If a neighborhood’s desirability or accessibility changes significantly, vacancy rates may change accordingly. Generally, the more popular a neighborhood, the lower the vacancy rates. The opposite tends to be true when a neighborhood falls out of favor.

Difference between homeowner and rental vacancy rates

We've spent a lot of time discussing rental vacancy rates, but there's another type of vacancy rate that’s relevant to homeowners. Let’s take a look at how rental vacancy rates differ from homeowner vacancy rates.

• Rental vacancy rates: Refers to the percentage of unused units in a rental property.
• Homeowner vacancy rates: Refers to the percentage of homes in an area that are vacant and for sale. With homeowner vacancy, we’re looking at any units with windows, doors, and floors — even if they’re still under construction.

While they refer to different figures, they are known to influence each other. Additionally, both rates can provide insight into the real estate market, which can help investors assess market conditions and property values.

Why is vacancy rate important?

Rental vacancy rates are important because they can help landlords and other investors make informed decisions regarding how to price their units, as well as when and where to invest or sell. Let’s take a closer look at how to interpret vacancy rates and how vacancy rates might inform investment decisions through careful analysis.

Analyzing vacancy rates

In general, a vacancy rate between 5-10% may be considered healthy, implying a balance between supply and demand. If the vacancy rate is under 5%, that could mean the demand for housing is greater than the supply. When demand outstrips supply, prices tend to rise, which may make it difficult for potential tenants to afford rental units.

Alternatively, if a vacancy rate is over 10%, it may mean the opposite — low demand and high supply. Vacancy rates that fall into this category may lead to lower rental prices, and subsequently, lower profits for the building’s owner.

In summary

In real estate, vacancy rates represent the percentage of an investment property’s rental units that are unoccupied. While high vacancy rates are generally viewed as negative, understanding how to interpret this data is generally a plus for investors. Analyzing these figures, low or high, may provide valuable insight and help owners price their units more competitively.