What it means
Physical vacancy is the simple version: count the units or square feet that are unoccupied and divide by the total available. It is easy to calculate and easy to compare across buildings, which is why it appears at the top of almost every property report.
The number matters because rent is the engine of property value. Every point of vacancy removes income while the mortgage, insurance, rates and management costs carry on unchanged, so vacancy hits net operating income far harder than it hits revenue.
Investors rarely underwrite a building at full occupancy. Appraisals and lender models typically apply a stabilised vacancy allowance drawn from the local market, often in the range of 5% to 10% for residential and higher for office, because assuming a permanently full building is wishful thinking.
Economic vacancy is the more honest measure for an operator. A block might be 98% physically occupied yet lose 8% of potential rent through two months of free rent given to new tenants, discounted renewals and a handful of non-paying occupants.
Context also matters enormously. A very low vacancy rate can be a sign that rents are set below market, and a spike in vacancy during a planned refurbishment programme is a different animal from a spike caused by tenants leaving for a competitor down the road.
In practice
Real-world examples.
Example
A retail landlord reports 4 empty units out of 50 in a shopping parade, an 8% vacancy rate. Because two of the empty units are the largest anchor spaces, the rent lost is closer to 19% of potential income, so the floor-area measure tells a much bleaker story than the unit count.
Example
A lender assessing a $9,000,000 office loan refuses to underwrite the borrower's assumption of 2% vacancy. It substitutes the submarket average of 12%, which cuts projected net operating income enough to reduce the loan offer by roughly $1,200,000.
Example
A self-storage operator notices vacancy has fallen to 2% across all sites. Rather than celebrating, the revenue manager raises asking rates by 6%, on the view that a nearly full facility is evidence that pricing has been left behind the market.
Think of it
“Vacancy rate shows how much of your property is empty-unleased space.
Formula
Calculation
Vacancy Rate = (Vacant Units / Total Units) x 100
Economic Vacancy Rate = (Total Rent Lost / Potential Gross Rent) x 100
An apartment portfolio has 240 units, of which 18 are empty. Average rent is $1,500 per unit per month.
Vacancy Rate = 18 / 240 = 0.075 = 7.5%
Potential Gross Rent = 240 x $1,500 x 12 = $4,320,000
Rent Lost to Empty Units = 18 x $1,500 x 12 = $324,000
That $324,000 of lost rent is 7.5% of potential gross rent, matching the physical measure exactly because every unit rents for the same amount.
Now add $60,000 of concessions, discounts and unpaid rent from occupied units:
Total Rent Lost = $324,000 + $60,000 = $384,000
Economic Vacancy Rate = $384,000 / $4,320,000 = 0.0889 = 8.9%
The building looks 7.5% vacant on a unit count but is losing 8.9% of its potential income, and it is the second number that drives value.Case study
Seen in the real world.
Ashgrove Properties is an invented residential landlord presented here as an illustrative case. It ran a 300-unit portfolio and reported a physical vacancy rate of 5%, which the board considered perfectly acceptable.
A new asset manager rebuilt the reporting around economic vacancy and found the true figure was 13%. Two months of free rent were being offered on almost every new letting, a renewal discount programme had quietly become standard, and about $110,000 a year of rent was simply never collected.
Ashgrove tightened tenant screening, replaced the free-rent offer with a slightly lower headline rent, and put collections on a weekly review. Physical vacancy edged up to 6% because fewer marginal applicants were accepted, but economic vacancy fell to 8% and net operating income rose by roughly $340,000, which is the illustrative point about measuring the right thing.
Watch out
Common mistakes.
- Reporting vacancy by unit count in a building with very different unit sizes, which hides the fact that one empty anchor space can outweigh several small occupied ones.
- Assuming zero vacancy is the goal, when a permanently full building usually means rents have been set below what the market would pay.
- Ignoring economic vacancy, so concessions, renewal discounts and uncollected rent never show up in the headline occupancy figure.
Questions
People also ask.
How is vacancy rate different from occupancy rate?
They are mirror images, since occupancy plus vacancy equals 100%, and which one gets reported is usually a matter of presentation.
What counts as a normal vacancy rate?
It varies sharply by property type and location, though stabilised residential assets in healthy markets often sit somewhere between 5% and 10%.
Does vacancy include units held off the market for refurbishment?
Practice varies, so good reporting separates units being renovated from units genuinely available but unlet.
From the founder's library
Take it further with the book.
Build your financial confidence beyond this definition. Shihan's full-length guide, Accounting Fundamentals, takes the same plain-English approach and turns it into a complete, practical playbook for non-finance managers, business owners and students - with chapter-end quiz answers and presentation slides included.
25% off with code MMHQ25, applied at checkout. Priced in USD - checkout may show the equivalent in your local currency.
View the book and save 25%