Breaking it Down: Physical vs. Economic Occupancy

Occupancy is defined as the number of units that are occupied over a period of time. This number is then converted to a percentage. For example, a 100-unit facility with 10 unoccupied units results in a 10% vacancy and therefore has 90% occupancy. In order to truly understand occupancy, we need to define vacancy and explore both physical and economic.  Vacancy is more than unoccupied units; it is any unit that is not creating revenue.

Physical vacancy is determined by the units that are currently empty and not generating income over a specified length of time. Let's use a 12-month time period, during the first 6 months of the year 10 units were unrented but during the second 6 months of the year, only 5 were unrented. For the year, physical vacancy would be 5%. It is important to remember that 100% physical occupancy is not the goal. In fact, there are multiple issues that can arise from facilities with 100% physical occupancy.

The most significant problem with having 100% physical occupancy---is that it does NOT allow revenue to be maximized!

Economic vacancy is the difference between the actual rental income and the gross potential rental income. Gross potential rent is considered the maximum amount of rent an owner or investor can expect during a specified time period. Economic vacancy goes beyond if the unit is occupied and considers tenants who have not paid, “unrentable” units (used by the manager or for company storage), turnover periods between renters, and incentives (1st first month). Using the same 100-unit example from above, let’s change some of the parameters and calculate economic occupancy.

There are 5 unrented/available units, 3 tenants who have not paid rent, 1 unit used rent-free by the manager, and 10 units receiving an incentive. To calculate the current economic vacancy, the formula below is used:

5% (unrented) + 3% (unpaid rent) +1% (“unrentable”) + 10% (incentives) = 19% Economic Vacancy or 81% Economic Occupancy

Although this property is 95% physically occupied, economic occupancy tells a different story. It is vital to understand the difference between the two calculations and more importantly how they impact the overall value of the facility. Understanding that true value is seen in economic occupancy allows for the greatest profit margins.  On average, a well-run facility has 90% economic occupancy. 

IMPACT ON VALUE
​Economic vacancy influences the value of a facility because it directly impacts the gross potential income a facility can generate this causes a direct relationship between economic vacancy and facility value. It is difficult for investors to justify their ROI when a facility has low economic occupancy, specifically with lenders. By examining each of the causes of economic vacancy, owners can see opportunities to improve their economic occupancy and property value.

MANAGING OCCUPANCY
​When assessing empty units avoid the idea that it is better to have them full. Waiting for tenants who are willing to pay market rates will always generate better long-term returns. Although it can be tempting to offer the first month free or various other incentives, they put owners at a deficit that isn't always recovered. Turnover cannot be avoided, but having a strong digital presence that includes a well-managed website can lessen the effects. Sourcing strategies to offset turnover, such as using a management company, can lessen the impact.  Lastly, take a hard look at all currently unrentable units and develop a plan to address them.

Proper management is the key to success with both physical and economic occupancy. Maintenance & aesthetics, digital lead sourcing & marketing, website management, business intelligence, revenue management, human resources, and accounting are all proven ways to run a successful facility. Owners who have chosen to outsource their facility management to a third-party, experience consistent returns with less hassle while still maintaining ownership of their facility.

ADVANTAGES OF 3RD PARTY MANAGEMENT 
Experienced management companies have perfected the art of running a successful facility. They understand promotion, rental rates, vacancies, staffing, digital presence, and aesthetics. Ownership remains intact, but now issues are handed off to the management company to address. This allows owners to keep the property (and its value) in their name without having to manage the facility.

Possibly one of the most compelling reasons to consider management is because of how management companies are paid. Most companies will charge a percentage of the monthly rental income. This makes them highly motivated to run the facility as efficiently and effectively as possible.