THE IMPLICATION OF VACANCY OF OCCUPANCY RATE TO PROPERTY INVESTMENT MARKET

A vacancy rate serves as an important indicator of the health of a real estate market. But we cannot draw sound inferences about a market just by observing the rate alone because many factors contribute to a vacancy rate. The same rate may tell different stories, and different rates may tell the same story.The vacancy rate is the percentage of all available units in a rental property, such as a hotel or apartment complex, that are vacant or unoccupied at a particular time. It is the opposite of the occupancy rate, which is the percentage of units in a rental property that are occupied. High vacancy rates indicate that a property is not renting well while low vacancy rates can point to strong rental sales.

 

The vacancy rate is calculated by taking the number of vacant units, multiplying that number by 100, and dividing that result by the total number of units. The vacancy rate and occupancy rate should add up to 100%.In real estate, the vacancy rate most often represents units that are vacant and ready to be rented, units that have been turned off upon the exit of a tenant, and units that are not currently rentable because they are in need of repairs or renovations. A property owner can use vacancy rates as a metric for analysis. Changes in the percentage of vacant units versus occupied units, the length of time occupied units are remaining active, or other rental conditions can provide guidance regarding how competitive a property owner has made the property. If a property owner is charging significantly more or less than the rest of the rental market, this may be reflected in the overall vacancy rates. It can also provide information regarding the effects of price changes or advertising on unit occupancy.

While vacancy rates are commonly used to assess an individual property's performance, such as a hotel monitoring its nightly vacancy rate, aggregate vacancy rates are also used as economic indicators of a real estate market's overall health. Many firms servicing the commercial real estate space gauge the strength of the overall industry using metrics such as vacancy rates, rental rates and construction activity. According to the natural rate hypothesis, fluctuations in apartment rents are driven by deviations in the vacancy rate from equilibrium or “natural” levels. One reason to estimate natural vacancy rates is to confirm this hypothesis. Beyond that, however, estimates of the natural vacancy rate for a rental housing market provide information that is potentially useful for investors, lenders and other real estate professionals. Comparing the natural rate at a point in time to the actualvacancy rate provides some indication of future rent movements in that market. In addition to itseffect on the movement of rents, the level of the vacancy rate has direct implications for thereturn on property investment. In long-run equilibrium, the lower the natural vacancy rate, thegreater the amount of rent generated by a given rental property, everything else held constant. If thenatural vacancy rate declines over time, the return on rental property investment will rise, ceteris paribus.

 

Housing markets are often modeled as a series of separate but related submarkets, with differing supply and demand conditions in each. In the case of a rental market, there may be separate submarkets for different apartment types (one-bedroom, two-bedroom, etc.), and for different geographic locations. If submarkets exist, it is possible that natural vacancy rates will vary by submarket. In that case, information on natural vacancy rates is made more useful if available atthe submarket level.

 

Empirical support for the existence of a natural vacancy rate in rental housing dates back to Smith (1974). Since then, a number of studies have focused on variations in the natural rate acrossboth space and time. For example, Gabriel and Nothaft (1988) provide evidence of substantialvariation across major U.S. metropolitan areas. In a more recent paper, Gabriel and Nothaft (2001)find the duration and incidence of vacancies, and the natural vacancy rate, to vary acrossmetropolitan areas with a number of factors including housing costs, heterogeneity of the housingstock, tenant mobility, and population growth.