Breakeven Occupancy

What is breakeven occupancy? The occupancy rate required to bear all the expenses of a multifamily real estate property. It is the ratio of the sum of operating expenses and debt service and the gross potential income (through rents, parking fees, etc.)

What is breakeven occupancy?

In a multi-family real estate property, breakeven occupancy is the point where the property’s operating expenses plus loan repayments is equal to the amount that the property generates in rental income. In other words, it is the point at which the property goes from operating deficit to operating profit. 

Why is it important for real estate investors?

The breakeven occupancy rate allows investors to determine whether it is a safe investment. By comparing the potential breakeven occupancy of the property with the historical occupancy of other similar properties, investors can better understand if the investment will be fruitful for them in the future. If a property is likely to have a low occupancy rate, the investor may decide not to invest in it. On the other hand, if the occupancy rate is predicted to be high, the investor would want to invest in it. 

How do you calculate breakeven occupancy for a rental property?

To calculate breakeven occupancy for a rental property, you need to determine the minimum percentage of units that need to be occupied for the property to cover all of its expenses. Here is an example of how to calculate breakeven occupancy:

Let's say you own a rental property that generates $10,000 in monthly rental income. The property has operating expenses of $6,000 per month, which includes property taxes, insurance, maintenance, and property management fees. Your monthly mortgage payment is $3,000.

To calculate breakeven occupancy, you need to divide your monthly operating expenses and mortgage payment by your monthly rental income.

Breakeven occupancy = (Operating expenses + Mortgage payment) ÷ Monthly rental income

In this case, the breakeven occupancy = ($6,000 + $3,000) ÷ $10,000

Breakeven occupancy = 0.9 or 90%

In this example, you need to have 90% of the rental units occupied to cover all of your expenses. If the occupancy rate falls below 90%, you will start losing money on the property. If the occupancy rate exceeds 90%, you will start generating profits.

Breakeven occupancy is just one metric to consider when evaluating the profitability of a rental property. Other factors such as vacancy rates, rental rates, and capital expenditures should also be taken into account.

Is breakeven occupancy different for commercial real estate properties compared to residential properties?

Breakeven occupancy is different for commercial and residential properties. Commercial properties usually have higher breakeven occupancy. This is because commercial properties generally have higher operating expenses such as maintenance, repairs, utilities, and property management fees. They also have longer lease terms and sometimes require the tenants to cover a large portion of the operating expenses such as property tax and insurance. 

Compared to this, residential properties such as apartments, condos and single-family properties have lower operating expenses and shorter loan terms. This results in lower breakeven occupancy.

However, the breakeven occupancy can vary significantly for both types of real estate properties depending on the location, size, economic conditions and finance terms. It is important to conduct a thorough analysis before making a decision to invest.

How can an investor use breakeven occupancy to determine the potential profitability of a real estate investment?

As with any investment, you want your profits to be higher than the expenses for that investment to be called a profitable investment. To calculate that amount, you need to determine the occupancy rate of the property and then compare that amount to the expenses incurred. 

If the occupancy rate is high, the rental income generated would be high too. This means that you will have more income to pay off the expenses and the debt for the property. Hence, the lower the breakeven occupancy ratio is, the better it is for you. 

You can use the formula provided above to calculate the breakeven occupancy ration and determine the profitability of your real estate investment. 

What factors can impact the breakeven occupancy rate for a property?

Whether it is a commercial property or a residential one, there are a few common factors that can affect the breakeven occupancy rate for a property. Let’s take a look at some of these:

• Location: If the property is built in a prime location which is easily accessible, the occupancy rate will be high and the breakeven occupancy ratio will be low. 
• Industrial growth: The growth in industrial projects in a particular area will see a higher density population and hence, a higher occupancy for various properties. 
• Rental rate: It is important to set a rental rate that you can justify to the tenants as keeping a higher or lower rent than your competitors can result in losses. This will greatly impact the breakeven occupancy rate.
• Amenities: If your property offers high quality amenities and services, the chances of people occupying it will be more. On the other hand, if you are providing only the basic features, your property may see lower occupancy rate.

Can breakeven occupancy be used to determine the optimal rental price for a property?

You can use the breakeven occupancy to set a rental price for your property as the rent will determine your income which you will use to pay for the expenses and debt against the property. To determine the optimal rental price you need to calculate your expenses and loan payments first. The total amount of all these expenses should then be compared to the total amount of rent that you will get from 100% occupancy. 

For example, let us assume that you have 10 apartments on your property. Your total expenses for the property including tax, maintenance, etc., is $5000 and your monthly mortgage payment is $2000. So, your total expense is $7000. 

Now if you keep the rent amount to be $700, your rental income will be $7000, which is equal to your operating expense and mortgage expense. In such cases, the DSCR will be 1.00. In this case, you can increase the rent amount to generate income that would be surplus.

However, there are other factors to consider too when setting a rental price such as demand, property value, economy, etc.  

Conclusion

Whether it is a commercial property or residential one, breakeven occupancy rate is an extremely important factor to consider before investing in a property. It will determine the profitability of your investment and maintain a positive cash flow. Even banks and other financial institutions that provide loans consider the breakeven occupancy ratio before they sanction the loan. Hence, be sure to gather as much information as you can before purchasing the property.