Previously we discussed the beauty of the Annual Property Operating Data and how it’s essential to understanding the health of a building. Now we’ll dive into the particulars of the line items in the APOD to better understand what we’re looking at. Usually the calculation after the potential rental income is the vacancy and credit losses line item. This is the income lost on a property due to vacant units and/or any of your current tenants defaulting on their rent payments. It’s a simple number to subtract but gets more difficult when you look into how you arrive at a vacancy rate. Offering memorandums can sometimes offer a lower vacancy amount to make the property look good, so it’s important to double-check the numbers. Here are some tips to understanding and checking vacancy and credit loss rates:
Review the rent history. When doing your due diligence, always ask for the landlord’s profit and loss statement on the property or the previous year’s tax returns. The further back the better, but the past three years should be sufficient. These should provide a snapshot on who is paying their rent and who is not. Chronic missed payments by a tenant could be a red flag that their business is not operating well and could be a vacancy in the near future.
Read the leases. This seems like a no-brainer, but it’s amazing how many transactions occur without investors getting original copies of the lease and reviewing them. Often the devil is in the details regarding options to renew, holdover rates, and the handling of late payments. These details can all affect your vacancy rate and lost income. Make sure you understand the landlord and tenant responsibilities.
Understand the competition. Knowing how a property operates is key; however, sometimes a property can be performing above or below the competition. In these scenarios, there may be upside to a property or their could be stiff competition for your tenant in the near future. Know what market rents are for similar properties and also what the current vacancy rate is. If you have a property that is 100% occupied, but the vacancy rate is 15% for the area, you may find that you will have to lower the rent or find yourself with a vacancy quickly.
Outside forces of supply and demand can alter a property’s profitability. So in addition to understanding your current tenants and leases, make sure you get a competitive analysis report to fully understand the property and the current real estate landscape.