physical and economic occupancy in apartment investing

Know Your Occupancy

Physical Occupancy vs. Economic Occupancy in Apartment Investing

Vacancy is the dreaded word in apartment investing. As an apartment investor, I focus on minimizing vacancy and getting occupancy as high as possible so our properties generate maximum income. Most people knowledgeable in real estate understand occupancy; however, there are two different types in apartment investing. It’s important to know the difference because one affects your rent roll, while the other affects what is most important – the income statement.

Physical Occupancy:

Physical occupancy is what most people are familiar with in apartment investing. It’s the number of units that have a tenant with a signed lease, occupying a unit. This is shown on the rent roll with the tenants name next to the unit number. The rent roll is a snap shot in time showing who’s living in any particular unit on the date that rent roll was generated. Any unit not occupied is labeled vacant and not generating income. Physical occupancy is calculated by dividing the number of occupied units by the total number of units.

Example:

On a 10 unit apartment, if 1 unit is vacant then the physical occupancy is 90% (9 ÷ 10)

But just because the rent roll shows a unit is occupied, doesn’t necessary mean it’s also generating income. There’s always the possibility of a tenant deciding to not pay rent.

Economic Occupancy:

Economic occupancy is the important factor in apartment investing. It’s the amount of money of actual rents received as related to the occupancy. Economic occupancy is the actual rental income the property generates, compared to what the gross income could potentially be (the potential if its 100% occupied). This takes into account all money transactions –and/or- lack of transactions, such as when tenants don’t pay rent and also things like concessions (discounts to motivate tenant prospects, such as a move-in discount). This is the net rents received (not including other income). The net income will deduct for bad debts (rents not received) and concessions (discounts). The economic occupancy is calculated by dividing net rent received by the gross rents possible.

Examples:

On the same 10 unit apartment, assume each unit rents for $1000/mo. There’s a gross potential of $120,000/year (10 units x $1000 = $10,000/mo x 12 = $120,000/year).

Let’s assume the equivalent of one unit is vacant for 1 year ($12,000 lost income). Another unit has a tenant that can’t afford rent anymore. They won’t voluntarily leave, requiring a month long eviction ($1000 lost income) and another month to fix the unit and rent up (another $1000 lost income, totaling $2000). The rent roll will still show the unit is occupied during the eviction period however there’s a loss of income during that period of time.

Economic occupancy is 88.3% = $120,000 – $14,000 {$12,000 + $2000} = $106,000/$120,000 = 88.3%.

You can see how economic occupancy can and typically does fluctuate lower than physical occupancy, because it’s directly related to the money transactions. In apartment investing it’s necessary to know the difference between these two measures when analyzing deals. A property that shows market rate physical occupancy but below market economic occupancy can be a sign that something or several things are wrong such as:

Mismanagement
Bad tenant qualification practices
Habitually late tenants
Bad rent collection practices
Lack of maintenance, causing tenants to leave

The Big Expense in Apartment Investing

What is Turn-Over?

In apartment investing, physical and economic occupancy are two different metrics that help you determine how well your apartment investment is operating. The bottom line is that physical occupancy is important, but economic occupancy is what determines how much money you’re going to make. How much money you make is the ultimate factor in determining how well you’re operating in apartment investing.

Did we leave anything out? Leave A Comment Below…