Occupancy Rates

Occupancy Rates (also known as 'occupancy levels') are a key performance metric used primarily in the real estate sector to show the percentage of available units in a property that are currently rented or in use. Imagine a 200-room hotel. If 180 of those rooms are booked on a given night, the hotel has an occupancy rate of 90%. This simple yet powerful figure is a vital sign for any business that rents out space—from apartment buildings and office towers to self-storage facilities and shopping malls. For a value investor, the occupancy rate is more than just a number; it's a direct reflection of demand, a property’s desirability, and its ability to generate consistent cash flow. A consistently high occupancy rate suggests strong demand and pricing power, while a declining rate can be an early warning of underlying problems.

At its core, the occupancy rate is a straightforward measure of success. It tells you how effectively a property's owner is filling their space and, by extension, generating revenue. A high rate is a green flag, signaling several positive attributes:

• Strong Demand: People or businesses want to be there. This could be due to a great location, superior amenities, or excellent management.
• Pricing Power: When a property is nearly full, the owner can often raise rents without scaring away tenants, directly boosting profits.
• Stable Cash Flow: Full properties generate predictable rental income, which is the lifeblood of any real estate investment, especially for REITs (Real Estate Investment Trusts).

Conversely, a low or falling occupancy rate is a major red flag. It can indicate a variety of issues, such as fierce local competition, a downturn in the local economy, poor property management, or that the rental prices are too high for the market. Value investors use this metric to gauge the health and competitive standing of a real estate asset.

While the concept is simple, understanding the nuances of how occupancy is calculated can give you a significant edge.

The calculation for the physical occupancy rate is as simple as it looks. You divide the number of rented units by the total number of units available.

• Formula: Occupancy Rate = (Number of Occupied Units / Total Number of Units) x 100
• Example: A suburban office building has 50 office suites. If 47 of them are currently leased, the calculation is:

(47 / 50) x 100 = 94% Occupancy Rate

Here’s where a sharp investor can dig deeper. There are two types of occupancy, and knowing the difference is crucial.

• Physical Occupancy: This is the simple metric we just calculated. It tells you how many units have a tenant physically in them.
• Economic Occupancy: This is the more telling figure. It measures the rent actually collected against the total potential rent (Gross Potential Rent). Why does this matter? A unit can be physically occupied by a tenant who isn't paying their rent due to a delinquency. That unit generates zero income. Economic occupancy cuts through the noise and shows you how much revenue the property is truly earning. A property might boast a 95% physical occupancy, but if 10% of those tenants aren't paying, its economic occupancy is much lower, and so is its actual profitability. Always look for economic occupancy when you can find it.

When analyzing a property or a REIT, don't just glance at the occupancy rate. Use this checklist to ask the right questions.

There is no single “good” number—it's all about context. A 95% rate is often considered the gold standard for a “stabilized” property, as it allows for normal tenant turnover. However, context is key:

• Property Type: A luxury hotel's occupancy will fluctuate far more than a self-storage facility's.
• Market: A 90% rate might be fantastic in a struggling market but mediocre in a booming one.
• Beware 100%: While it sounds perfect, a 100% occupancy rate sustained for a long time might paradoxically be a bad sign. It often means the owner isn't charging enough rent and is leaving money on the table.

A single occupancy rate is a snapshot in time. What a savvy investor wants to see is the trend over several quarters or years.

• Is the rate rising? This suggests improving management effectiveness or favorable market conditions.
• Is it falling? This is an alarm bell. You need to find out why. Is it a company-specific problem or a wider market downturn?
• Is it stable? This indicates a mature, predictable asset.

Never analyze an occupancy rate in a vacuum. The most valuable insights come from comparison. How does your target investment's occupancy rate stack up against its direct competitors in the same city and asset class? If a REIT's office buildings in Chicago have a 94% occupancy rate while the city average for similar buildings is only 85%, you've likely found a company with a strong competitive advantage. If it's the other way around, you know to be cautious.