Profitability Considerations:

Budgeting for Vacancies – Your Occupancy Rate

A Realistic Occupancy Rate
When planning for an occupancy rate I try to anticipate how many months a year that I can count on collecting rent. Obviously, there is a difference between someone occupying a property and paying rent. You would be surprised how many owners tell us they are 100% occupied but are not coming close to collecting 100% of their potential rent. You may also be surprised at how many people buy investment property with the assumption that it will never be vacant. That is what I call Magical Thinking, but I digress.

How Many Months of Rent Should You Count on Collecting a Year?
On a lower end property, and depending on our experience in the neighborhood, I may only budget for collecting rent 10 months of the year. This means I am planning on collecting rent worst case, 83% of the year. (10 months / 12 months = 83.33%) I will round down a bit and say my vacancy rate will be 15%. So if my monthly potential or market rate rent is $500 a month, or $6000 a year, I build my budget with the understanding that am only going to collect 85% of that, or $5,100 a year. ($6000 potential rent X .85 = $5100 budgeted annual income.)

I Budget to Collect 90% of My Potential Rent
On average, I plan to collect rent 90% of the time and to be vacant 10% of the time. This equates to successfully collecting rent roughly 11 times every 12-month period. It is virtually impossible to collect rent every month during the life of an investment. Even if a tenant stays in a house for two full years, it is very likely that you will miss at least one month’s rent between tenants and likely two depending on the time of year and the time it takes to prepare the home for the next tenant. One vacant month out of 24 equals means a 95% occupancy rate and two out of 24 brings us back to 90%.

The Eviction Process
At some point you will have a tenant that fails for whatever reason to pay their rent. It is important to stress with your tenant at the start of the relationship that the rent is always due in your office on the first of every month and if it is not there by the 5th, they are subject to both late fees and an eviction. Our philosophy is rent is due on the first and if we don’t have it by the morning of the sixth day of the month, they can expect an eviction notice to be posted on the property giving them three days to move out. After the three days have passed, we have the right to file the eviction with the local municipal court.

This Is A Business
I know what you are thinking; nice people don’t evict people. We consider our owners to be nice people too and they deserve a consistent return on their investment. Having said that, if we have good history with a tenant and if they are upfront about their situation and have a plan to get current, we will bend the policy with the owner’s consent. In most cases however, we start the eviction process while at the same time suggesting possible sources of financial help in the community the tenant may be able to turn to.

Evicting People is Not Pleasant
For most people, having to evict a tenant is the most distasteful part of being a landlord. Failure to carry out an eviction in a timely manner however, will negatively impact your return on investment. In our experience, if we act early in the month and put the eviction process in motion, we can usually get a court date early the following month and have possession of the house soon after that. Best case our landlords will lose two months’ rent. If we hesitate just a few days however, we can easily lose three months’ rent.

In our county filing an eviction costs $130.00 in court costs and we have an attorney that works with us that charges $125 for his signature on the court documents. A writ of possession and a visit from the sheriff is another $25.00. Our property managers file the eviction and attend eviction court. We do not charge extra for this service, but we do pass along the $280.00 in court costs and attorney fees to our owners.

The majority of the time the tenant will come up with the money owed in addition to the court costs and attorney fees and remain in the property. Maybe a third of the time they vacate the property on their own prior to the court date. Once in a while the tenant will remain in the property up until the bailiff and the sheriff arrive to execute the writ of possession. At that time, they are escorted off the premises. That as you can imagine is never pleasant. but it is one of the things you pay a property manager to do.

Late Fees Some of our owners stipulate a late fee of $5.00 a day after the fifth of the month and others charge a flat percentage of the monthly rent after the fifth.  The idea is to discourage tenants from taking their time getting the rent in each month.  The late fees also compensate the owner for late income they may need to meet their monthly obligations.  Unpaid late fees are deducted from the tenant’s security deposit at the end of the lease term.

I hope this piece helps you think through the process of creating a realistic budget for our rental properties. Facing the financial realities up front will save you grief down the road. Trust me, I speak from personal experience.

Care to Learn More?

Are you interested in diving deeper in to your personal mindsets and motivations as a real estate investor? Set aside 15 minutes and complete the Making Real Estate Work Mindset Scorecard. You will get instant results and insights to your own personal view of the business you may not even be aware of.

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