Vacancy & Credit Losses in Commerical Real Estate

Commercial lenders establish the vacancy/expense factors for their underwriters based upon geographical boundaries of a specific area, population density, and business use. The standard for most high-density populated areas is 5% (vacancy) and 35% (expenses).

Some clients will inquire about the vacancy percentage calculated at the 5% amount when there were no vacancies at the subject property over the last 12 months. The lender has account for any possible future vacancies even if there are none currently reflected on the rent roll or over the past year. And there could be changes in the operating expenses so as standard of practice a good commercial broker will view the deal through the eyes of the lender because they are a vital part of the deal.

A commercial broker must also be able calculate vacancies and credit losses that may be over the lender standard.

Below is one example:

Take the Gross Scheduled income $100,000.00 annually
Calculate the Vacancy and Credit Losses by reviewing the past 12 months of vacancy activity at the subject property.

VACANCY LOSSES

Example: 3 months of one unit being vacant that rented for $2,000.00 a month is $6,000.00 or 6% of $100,000.00 = Vacancy Losses Annually $6,000/$100,000=0.06

Total Vacancy Loss $6,000.00

CREDIT LOSSES

Example: Three tenants fell one month behind; their rent was $2,200.00, $2,250.00 and $2,300.00 for a total of $6,750.00 or 6.75%= Credit Losses Annually $6,750/$100,000=0.0675.

During a survey of three comparable properties sold within a one-mile radius of the subject, it was determined that there was one property with two months vacancy at $2500 a month and no non-payment issues= $5,000.00

Note: the comp’s vacancy was factored in with the loss of the subject property not as a percentage of the comp’s annual gross income

Total Credit Losses=$11,750.00

Total losses = $17,750.00 or 17.75%

Gross Schedule Income $100,000.00
Minus Vacancy/Credit Losses @ 17.75% or $11,750.00
Equals Gross Effective Income: $88,250.00
Minus Fixed/Variable Expenses: $32,000.00 or 32%(Gross Schedule Income minus Expenses)
Net Operating Income=$56,250.00(Gross Eff Inc minus Expenses)

Purchase price: $1,500.000.00/$56,250.00=0.0375

Note: do not capitalize market rents to obtain a higher cap rate.