No apartment building collects every dollar of rent it could in theory charge. Units turn over and sit empty for a few weeks, new tenants are offered a free month, some tenants pay late or not at all, and long-term residents often pay less than a new tenant would. Underwriting has to account for all of this before it reaches net operating income. The terms can be confusing, so this guide separates them, shows how they fit together and walks through a simple example.
Key takeaways
- Physical vacancy is empty units; economic vacancy is all rent you do not collect.
- Concessions, bad debt and loss to lease all sit between scheduled rent and collected income.
- Use the building’s own history, not a round number, to set your allowance.
- In Seattle, loss to lease on existing tenants tends to close slowly.
Four ways income falls short of rent
Physical vacancy is the simplest: a unit with no tenant produces no rent. Concessions are discounts offered to sign a lease, such as a free month or a reduced first few months. Bad debt, or credit loss, is rent that was charged but never collected. Loss to lease is the difference between what current tenants pay and what the same units would rent for today. Add the first three and you have economic vacancy: all the scheduled rent that did not turn into cash. Loss to lease is tracked separately because it is not lost income in the accounting sense; it is income the building never charged.
An example with made-up numbers
| Line | Amount per year |
|---|---|
| Market rent for all 20 units | $456,000 |
| Loss to lease (current rents below market) | -$21,600 |
| Gross scheduled rent at current rents | $434,400 |
| Physical vacancy (turnover gaps) | -$13,000 |
| Concessions | -$3,600 |
| Bad debt | -$4,300 |
| Collected rent | $413,500 |
In this example, economic vacancy is $20,900, or about 4.8% of scheduled rent. A buyer who used market rents with no allowance would have started from $456,000, more than $42,000 a year above what the building actually collects. At a 5.5% cap rate that gap alone is worth over $750,000 of price. The calculation of value from income is covered in Cap Rate vs. Cash-on-Cash Return: Which One Tells You More?.
Setting a vacancy allowance
The best guide is the building’s own record. Look at collected rent against scheduled rent in the trailing twelve months, and if possible for the year before. Ask how long units typically sit between tenants and how often they turn over. A small building is lumpy: one empty unit in a six-unit building is almost 17% physical vacancy for that month, so averages over a full year or two are more useful than a single snapshot.
Lenders usually apply their own minimum vacancy factor even if the building has been full. Using a similar or slightly higher allowance keeps your numbers close to the lender’s and avoids surprises when the loan is sized.
A short case
Picture a buyer looking at a building listed as 100% occupied. The rent roll confirms every unit is leased, but three of the leases started in the last two months, each with one month free. The trailing twelve months show collected rent well below the current rent roll. Asked about it, the seller explains that the building had several empty units earlier in the year while they renovated. None of this is a problem in itself, but it means the building has not yet shown a full year at current rents, and the buyer’s underwriting uses the collected figure plus a realistic allowance, not the listing’s full-occupancy number.
Tip: Separate one-time events from normal turnover. A renovation that emptied units last year should not set your ongoing vacancy rate, but normal turnover should.
Loss to lease in a Seattle building
Loss to lease is often presented as upside. In Seattle it is real, but slow. Most annual increases on existing tenancies are capped under Washington law, Seattle requires 180 days of written notice before an increase, and large increases can trigger relocation-assistance obligations. That does not stop rents from rising, but it means the gap closes gradually and only as far as the rules and the market allow. Model it year by year rather than as an immediate jump. The detail is in Washington’s Rent Increase Limit and What It Means for Your Projections.
Common questions
Should I use market rent or current rent?
Use current rent for the base case. Market rent is an estimate and is only reached as units turn over or as allowed increases add up.
Do concessions count as vacancy?
They reduce collected income, so they belong in economic vacancy. Show them on their own line so you can see whether they are growing.
Is a fully occupied building a sign of low rents?
Sometimes. A building that never has a vacancy may be priced below the market. Compare its rents with nearby listings before drawing a conclusion. The rent roll checks in How to Read a Rent Roll Before You Make an Offer help with that.