How Economic Occupancy Can Help You Maximize Rental Income

If you own a rental property or invest in real estate, you probably know the importance of occupancy. Your rental income is dependent on tenants paying their rent every month. If a unit is vacant or a tenant has missed rent, you’re missing out on potential income.

Rental property owners and property managers measure the efficiency of this income through economic occupancy. We’ll discuss what economic occupancy is, how to calculate it and what it could mean if your economic occupancy rate is low.

What Is Economic Occupancy?

Economic occupancy considers what a rental property is making against what it should be making. In well-managed buildings, this economic occupancy should be in the 90% or better range, while a ratio of less than 90% might indicate underlying management issues.

To maximize income, rental properties need to be managed. A couple of key metrics are used to measure occupancy. They are physical occupancy and economic occupancy.

Economic Occupancy Vs. Physical Occupancy

Physical occupancy is a measurement of the total income coming in. Economic occupancy takes the physical occupancy and measures it against the total possible income if a property is 100% occupied and tenants are paying the full market value in rent.

How Do You Calculate Economic And Physical Occupancy?

Before we get into an example of calculating physical and economic occupancy, you’ll want to know the economic occupancy formula: Rental Income / Gross Potential Rent ✕ 100.

Monthly Physical And Economic Occupancy Calculation

Now let's say you have a rental property with four units. Standard rent for each unit is $1,000 a month. Three units are occupied and one is vacant this month. With 25% of the property vacant, your physical occupancy is 75%.

If all tenants are paying the full rent, the economic occupancy is the same as the physical occupancy. But for this example, let’s say that one of the tenants has a discounted rent of $800/month as part of an introductory deal.

To calculate the economic occupancy, you must first add up the three paying tenants’ rent:

Step 1: $1,000 + $1,000 + $800 = $2,800

Next, divide the total rent collected by the total possible rent income (4 units):

Step 2: $2,800 / $4,000 = 0.7 or 70% economic occupancy

This example showcases how to calculate physical and economic occupancy on a monthly basis, but the same formula can be applied to calculate the yearly occupancy rates.

Yearly Physical And Economic Occupancy Calculation

First start by calculating your maximum yearly occupancy by multiplying the total maximum monthly income by 12.

Step 1: $4,000 x 12 = $48,000

Then factor in your physical occupancy. For this example, we’ll say that on average, there was a vacant property for 4 months of the year.

Step 2: $48,000 – ($1,000 x 4) = 44,000

Step 3: $44,000 / $48,000 = 91.6% physical occupancy rate

Next, we’ll factor in the discounted rent given to one renter. This renter received $200 off rent for three months, or $600 in concessions.

Step 4: $44,000 – $600 = $43,400

Step 5: $43,400 / $48,000 = 90.5% economic occupancy rate

As you can see, the discount did not affect the yearly economic occupancy rate much. Another factor that would negatively impact this rate is having a tenant miss rent and having to evict.

What Does It Mean If My Economic Occupancy Is Over 90%?

Now, 90% is a key metric for economic occupancy which suggests the property is well-run, prices are fair and tenants are satisfied. While 100% economic occupancy is rare, it should be the goal.

What Does It Mean If My Economic Occupancy Is Under 90%?

Every business, including rental properties, has bad months or periods with less income. An economic occupancy rate of less than 90% for a few months or year is unlikely to spell ruin for you, though.

Though this is not always in your control, here are some reasons why your occupancy can dip and what you can do to address it.

Rent Is Set Too High

If multiple tenants are having trouble paying their rent, your rent could be too high. Take a close look at comparable rentals in the area, as well as your costs. Lowering your rent may mean collecting less per unit, but it may keep more units occupied.

Too Many Vacancies

Your economic occupancy rate is going to be either equal to or less than your physical occupancy rate. Too many vacancies mean your baseline occupancy rate is low, and you’re not collecting the amount of rent you should be.

Vacancies happen for a variety of reasons. Tenants may feel the property needs better maintenance and security. Or outside factors could be influencing vacancies, like an economic downturn or problems with the neighborhood.

Too Many Incentives

If you offer a discount, also known as a concession, this will factor into your economic occupancy rate. It’s helpful to know how these discounts will affect your economic occupancy rate before offering them. Gaining new tenants through a discount may outweigh a dip in your economic occupancy rate.

Tenants Aren’t Willing Or Able To Pay

You lose out on income if your tenants aren’t willing or able to pay. The best way to solve this is to prevent it to begin with good tenant screening. Verifying employment, checking credit scores and performing background checks is where you need to start in screening for reliable tenants.

Another reason tenants may not pay is if they feel their problems aren’t being responded to or taken seriously. If this becomes a regular occurrence, it’s a strong sign your property isn’t being regularly maintained. You and/or your property manager need to increase your responsiveness to tenant problems.

The Bottom Line: Economic Occupancy Can Help Measure Profitability

The key takeaway is that ignoring economic occupancy could translate into your not making the most out of your rental property. It could also mean you’re unaware of management problems or property issues. In order to keep a rental property running at peak profitability, the building must be maintained and filled with tenants paying their rent on time for a long time.

Empty units mean lost revenue, and evictions are even more costly. Doing the work to properly price your rental and screen tenants will help you keep your economic occupancy rate up. By understanding this rate, you can use it to help gauge your success.

Want to learn other ways you can measure profitability? Read more about key real estate investor metrics in our Learning Center. If you think you’re ready to buy an investment property, start an application today.