Vacancy Rates - How Much Is Enough
Vacancy rates in commercial real estate can seem like a mystery when we look at them in isolation. But they’re an indicator of the economy and growth around it. They also interact with other aspects of the property and help us anticipate how it will perform in the future. As a thumb rule, anything below 10% is considered a healthy rate and anything less than 5% is considered excellent. Coupled with the grade of the assets available, vacancy rates can tell an investor about the probable future of investing in an asset. Let us explore how vacancy rates work and understand them better.
Why Understanding Vacancy Rates in Commercial Real Estate is Important
Property meant for rental or leases should ideally avoid vacancy. In the context of residential real estate, this means a death blow to profitability for independent investors and landlords. Tenant turnover, for commercial real estate (CRE) and residential real estate (RRE), is damaging. A vacant property draws in costs like - maintenance, advertisement, management, cleaning, and even mortgage payments (in some cases). If one considers an average residential flat of 2000 sq. ft., the time and resources involved in the upkeep can easily amount to a monthly cost of INR 1000-3000 in most urban areas. If that is considered as a benchmark and commercial spaces with better ventilation, carpet areas, meeting rooms, cafeterias are added to the equation, the monthly expenses can come up to at least INR 30 per square foot of the area involved.
Now, if you consider that a property doesn't generate returns, you can easily understand how much of the management costs can eat into your funds. Thus, a market's vacancy rate is important, to avoid such plausible pitfalls.
Understanding the Timing and Location for Vacancy Rates
The vacancy rate of an individual building and year will vary depending on many factors, including the market's absorption and construction rates, the service level of rental units, local economic conditions, and new employment dynamics.
All these factors are typically long-term. Thus, understanding the timing and location also makes sense. No two locations will always have the same factors affecting the vacancy rates in the same manner or to the same degree. Underestimating vacancy rates is one of the biggest mistakes a real estate investor can make.
Calculating the Vacancy Rate
There are two different ways in which vacancy rates can be calculated and both ways indicate different aspects of planning a great investment portfolio.
The vacancy rate of a market is calculated by dividing the number of vacant units (U0) by the number of available units (U) in the area being considered. This makes the formula U0/U * 100. This calculation can be done over the course of one year or more.
The vacancy rate of a single property is calculated by dividing the number of days the property was vacant by the number of rentable days. Generally, this calculation is done over a period of a year.
For commercial real estate investments, however, the vacancy rate calculation mentioned earlier is considered.
Taking Vacancy into Consideration When Investing
There are many different factors that go into deciding when to invest in a property. How confident are you in your investing abilities? How much money are you ready to risk on an investment? Do you know how to maximize the resale value of the property? And last, but not least, how has the vacancy rate been historically in an area.
Unforeseen circumstances like the lockdown ensuing from the pandemic situation caused a sizeable increase in vacancy rates, especially in areas where the lease terms were expiring. The economic slowdown of a nation can also reflect in the vacancy rates of larger business hubs. The best idea would be to consider all the best and worst times of an economy and look at the complete picture.
If a market is resilient enough to rise to a couple of points above 10% vacancy rates even under duress, it will be a good area to look for CRE assets to invest in the long term.
As an investor, it is important that you track vacancy rates over the long term before investing in CRE. Real estate investment is illiquid, but you can improve your liquidity options herein by choosing to go with fractional ownership as an investment channel. To know more about how fractional ownership works, please visit us at www.strataprop.com.