Economic vs Physical Occupancy

This article will help explain why you should shift your focus from full occupancy to full profit. Realizing economic occupancy is important because it provides a more accurate measure of the true financial performance and efficiency of a business or property. Regular occupancy, which simply measures the physical occupancy of a space or property, does not take into account the revenue generated by that occupancy or the associated costs.

Economic occupancy, on the other hand, considers both the revenue generated by occupied spaces and the expenses incurred to maintain and operate those spaces. It takes into account factors such as rental income, lease terms, concessions, vacancy rates, delinquency and operating expenses. By considering these financial aspects, economic occupancy provides a more comprehensive understanding of the financial viability and profitability of a property or business.

In multifamily real estate, occupancy and economic occupancy are two related but distinct concepts that provide different perspectives on the utilization of rental units within a property. A high economic occupancy helps ensure a steady cash flow from rental income. Sufficient rental income allows property owners to cover operating expenses such as property maintenance, repairs, utilities, property management fees, and debt service payments. A low economic occupancy can lead to financial strain and difficulty in meeting these obligations. Here’s an explanation of each term:

1. Occupancy: Occupancy refers to the physical occupancy or physical presence of tenants in the rental units. It represents the percentage of occupied units out of the total available units in a multifamily property, regardless of whether the tenants are paying rent or not. For example, if a building has 100 units and 90 of them are occupied by tenants, the occupancy rate would be 90%.
2. Economic Occupancy: Economic occupancy, on the other hand, takes into account not only the physical occupancy but also the financial aspect of tenancy. It represents the percentage of units that are both physically occupied by tenants and generating rental income for the property owner. Economic occupancy considers factors such as vacancy loss, loss to lease (basis below market rent) non-payment of rent (delinquency), and concessions given to tenants. It provides a more accurate measure of the property’s financial performance and the ability to generate rental income.

Here are some key reasons why realizing economic occupancy is important:

1. Financial Performance Assessment: Economic occupancy allows property owners, investors, and managers to assess the financial performance of a property or business accurately. It provides insights into revenue streams, cash flow, and profitability, enabling informed decision-making and strategic planning.
2. Revenue Optimization: By analyzing economic occupancy, operators can identify opportunities to maximize revenue. This includes setting appropriate rental rates, adjusting lease terms, implementing effective marketing strategies, and reducing vacancy rates.
3. Cost Management: Economic occupancy helps in managing operating expenses more effectively. By understanding the true cost of occupancy, businesses can identify areas where costs can be reduced, negotiate favorable vendor contracts, and implement efficient maintenance and operational practices.
4. Lease Management: For property owners and managers, economic occupancy provides a clearer picture of lease performance. It allows them to identify leases that are underperforming or may require renegotiation. By evaluating lease terms, rental rates, and overall lease economics, businesses can optimize lease agreements to enhance financial returns.
5. Investor Insights: Economic occupancy is crucial for investors assessing the viability of a property or business. It provides a basis for evaluating return on investment (ROI), cash flow projections, and the potential risks and rewards associated with the investment.
6. Revenue Generation: Economic occupancy directly affects the financial performance of multifamily properties. Higher economic occupancy means more units are rented out and generating rental income. This, in turn, increases the property’s cash flow, profitability, and overall return on investment for property owners and investors.
7. Property Valuation: Economic occupancy plays a crucial role in determining the value of a multifamily property. Real estate valuation methods, such as the income approach, consider the property’s rental income potential. Higher economic occupancy indicates a stronger income stream, which can positively impact the property’s market value.
8. Lender and Investor Confidence: Lenders and investors consider economic occupancy when assessing the financial health and risk profile of multifamily properties. A high occupancy rate signals stability, consistent rental income, and reduced investment risk. This can increase the likelihood of securing financing, obtaining favorable loan terms, and attracting potential investors.
9. Risk Mitigation: Maintaining a high economic occupancy helps mitigate financial risks associated with vacancy and turnover. Vacant units result in lost rental income, while frequent turnover increases leasing costs, advertising expenses, and potential periods of non-revenue generation. By maximizing economic occupancy, property owners can minimize these risks and stabilize their rental income stream.

Overall, multifamily economic occupancy is crucial for the financial success, property valuation, market competitiveness, and risk management of multifamily properties. It directly impacts cash flow, property value, investor confidence, and the ability to meet financial obligations. By considering both revenue and expenses, economic occupancy provides a more accurate measure of success and enables informed decision-making.