We all know what vacancy is. And it’s got the same meaning in the real estate industry as well. Nothing different. However, there is also this thing called Natural Vacancy and in the real estate industry, it is one of the factors that affect real estate valuation by investors.
So why is there such a thing called Natural Vacancy? Does this mean such kind of vacancy is normal?
WHAT IS VACANCY RATE
Vacancy rate in the real estate industry represents all space that is currently unoccupied and available for occupancy. That, in its sense, also includes the space that currently may be under lease, but available for subleasing. I know, right? Who would have thought.
Usually vacancy is caused by the fact that developers have to start taking up projects in the absence of perfect information about the demand for real estate. This is because such construction projects are to take years to finish. No wonder development companies don’t possess the right information for supply and demand forces for years and years ahead.
WHAT DOES VACANCY RATE HAVE TO DO WITH SUPPLY & DEMAND
There are a number of factors in the real estate industry that affect supply and demand for space. These are as follows:
- Vacancy rate (includes natural vacancy rate as well)
- Quantity of new construction started
- Quantity of new construction completed
- Absorption level for new space
- Level of rent
As you can see, vacancy rate and thus, natural vacancy rate, is one of the factors affecting supply and demand forces in the real estate industry. But rather than being an indicator of supply or demand, vacancy rate is more of an indicator of equilibrium for the real estate industry. Think of it as a force opposed to the level of rent.
When the vacancy rate is below natural level, the market is said to be that of landlords’ (sellers’ market). This means that demand exceeds supply in some sense. Conversely, when vacancy rate is above natural level, the market is said to be buyers’, meaning that is some sense supply exceeds demand.
When vacancy is below normal, rents are expected to rise in the future and when they are above normal vacancy rate, rents are expected to fall.
Real estate economics seems fun, right? However, there is so much more to it. Make sure you go through several of our economics related articles, such as What is CAP Rate in Real Estate?
SO WHAT IS NATURAL VACANCY?
It is important to keep in mind that it is normal for the real estate industry to have some vacancy. This happens because the landlords are not willing to make the deal happen with just anyone, depending on the amount of rent they are ready to pay. And it’s the same with the potential tenants as well- they are not willing to make the deal happen with the first landlord they stumble across.
So it takes time for the deal to actually happen. And this time translates into natural vacancy.
This is why most of the lease contracts usually bind both parties to commit for a long period of time – because when a tenant moves, there eventually will be natural vacancy for some period of time, unless the landlord can find a new tenant right on the spot, which is impossible, right? This is especially true for commercial properties – most of the time such lease contracts are for years and years.
Therefore, both for landlords and for tenants, future economic benefits will be maximized if both parties take their time to find the right deals. So to this extent, some vacancy is, indeed, normal in the real estate industry. Have a burning question or two? Leave a comment down below.