You might be surprised to learn how many owners claim to have their units 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.
When planning for an occupancy rate, an essential task for any investor or real estate owner, I try to anticipate how many months a year I can realistically count on collecting rent. Certainly, there is a difference between someone occupying a property and actually paying the rent they owe.
“There is a difference between someone occupying a property and actually paying the rent they owe.”
How many months of rent should you count on collecting a year?
On a lower-end property, and depending on your experience in the neighborhood, it may make sense to only budget for collecting rent 10 months of the year. I do this, and it means I am planning on collecting rent 83% of the year, in the worst case — though I tend to round down a bit and project my vacancy rate to be 15%.
So, if the unit’s monthly potential or market rate rent is $500 a month, or $6000 a year, build your budget with the understanding that you may only collect 85% of that, or $5,100 a year.
On average, you may 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. In my experience, it is virtually impossible to collect rent every month during the life of an investment. Even if a tenant stays in a unit for two full years, it is very likely that you will miss at least one month’s rent between tenants, and more 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 you back to 90%.
On average, you may plan to collect rent 90% of the time and to be vacant 10% of the time.
Some property owners stipulate a late fee to the tune of $5 a day after the fifth of the month, and others charge a flat percentage of the monthly rent after the fifth. The idea of a late fee 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 may be deducted from the tenant’s security deposit at the end of the lease term.