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Introduction

Vacancy rates are a critical metric that investors carefully analyze when acquiring and monitoring real estate deals. While a lower vacancy rate generally indicates higher returns, it is not the sole determinant of a property’s potential. In some cases, a property with full occupancy may still have untapped potential if its rental rates are below market value. This intriguing scenario captures the attention of our team at Rolling Rook Capital and many other experienced investors in the industry.

When a property is fully occupied but has rental rates below market value, it signifies an opportunity for significant cash flow optimization. Striking the right balance between occupancy and rental rates is crucial, as advertising excessively high rents may drive up vacancies. Instead, maintaining rental rates within a certain threshold, typically ranging from 87% to 92% occupancy, can optimize cash flow and create a desirable financial outcome.

What Story Does A Property With High Vacancies Tell?

Understanding the story behind a property with high vacancies is key to unlocking its full potential. By making strategic adjustments, investors can enhance its performance and capitalize on new opportunities. However, it is equally important to recognize the challenges associated with a property at full occupancy.

One challenge arises from excessive spending on advertising to maintain full occupancy. While achieving full occupancy may initially seem appealing, the costs associated with continuous advertising can significantly impact profitability. Additionally, charging rents that are too low or offering discounted rates, often referred to as “loss to lease,” can result in missed revenue opportunities and hinder long-term financial growth.

How Can This Be Adjusted?

It is essential for investors and operators to navigate the delicate balance between maintaining yield, avoiding negative cash flow, and driving substantial rent growth. This multifaceted task requires careful consideration and strategic decision-making. Adopting a cautious approach that ensures sustainable growth while maximizing cash flow is key.

Industry experts have challenged conventional thinking when it comes to occupancy rates and rental strategies. Scott Everett, the founder of S2 Capital, believes that the fear of slightly lower occupancy rates, such as 87%, can hinder overall progress. He advocates for a more aggressive approach, aiming to quickly reach occupancy levels of 82% to 85%. By rapidly adjusting occupancy rates, investors can create more significant value and generate a capital event sooner, thereby avoiding potential disappointments from slow growth.

“A lot of people miss the boat when driving rents and maintaining occupancy. It really is a delicate balance – to maintain yield, to not go cashflow negative, and be able to drive massive in place rent growth is a challenging thing to do. And a lot of times people’s growth is slow, they get behind the eight ball because they are scared of occupancy. People have this fear of being 87% occupied – it seems like to them they are failing, their NOI sucks, its not a great deal. We want, if the investor will let us, to go right to 82%-85% as fast as we can. All I want to do is go down fast and up fast. The worst thing people can do is this slow growth. You haven’t generated enough NOI value to actually create a capital event now your investors are upset and your IRR is crushed.“

Scott Everett – Founder of S2 Capital

Another perspective comes from Nick Huber, the founder of Bolt Storage, who emphasizes the potential loss in cash flow and future sale value when a portfolio is fully occupied. Huber suggests pushing rental rates until occupancy levels range from 85% to 93%. This strategy allows investors to maximize cash flow and create additional value from their investments, both in terms of ongoing income and potential future sale proceeds.

“100% occupancy on a multifamily or self storage portfolio means you’re leaving tens of thousands a month on the table from a cashflow perspective and millions on the table at sale. Push rents until you’re at 85-93%.“

Nick Huber – Founder of Bolt Storage

Wrapping It Up

In conclusion, vacancy rates play a pivotal role in assessing the performance and potential of real estate investments. Striking the delicate balance between occupancy rates and rental rates is crucial for optimizing cash flow and overall property value. By challenging conventional notions and adopting strategic adjustments, investors can maximize their returns and create greater value from their real estate portfolios. It is through such thoughtful analysis and innovative approaches that the full potential of properties can be realized, leading to long-term success in the dynamic world of real estate investment.