While a vacancy drags on, rental income disappears, but fixed costs that accrue simply because you own the property keep coming due. Here's what those costs are, how they affect cash flow, and how to prepare for them.
- Fixed costs such as property tax, city planning tax, fire insurance, and common area fees keep accruing during a vacancy.
- Depending on the management company, a base management fee may still apply even during a vacancy.
- A prolonged vacancy raises the risk of deteriorating cash flow, making it important to keep working capital in reserve.
- Sublease can transfer vacancy risk, but the fee it charges needs to be weighed against that benefit.
- Visualizing fixed costs as an annual figure makes management decisions easier.
Fixed Costs That Keep Accruing During a Vacancy
Certain costs accrue as long as you own the property, whether or not there's a tenant in it. The main ones are property tax and city planning tax, fire insurance premiums, and — for a sectional-ownership property — association dues and common area fees. If you've outsourced management, the contract may call for a base management fee even during a vacancy, so it's worth checking the terms. Because these costs are fixed regardless of rental income, it's important to factor them into your management plan.
The Risk of Deteriorating Cash Flow From a Prolonged Vacancy
Because fixed costs keep being due while rental income has stopped, the longer a vacancy drags on, the more cash flow tends to deteriorate. If you financed the purchase with a loan, the loan repayment adds to the burden, making the impact on cash flow even larger. It's worth building a financial plan with some margin in case the vacancy runs longer than expected.
How to Think About the Working Capital You Should Keep on Hand
Keeping enough working capital in reserve to cover several months of fixed costs and management fees during a vacancy makes it easier to respond calmly to an unexpected vacancy. If you own multiple properties, it's also worth factoring in the differing vacancy risk of each property when planning your overall reserves.
How Sublease (Rent Guarantee) Differs
Sublease (rent guarantee) is one option for preparing for vacancy risk. Under sublease, a guaranteed rent is paid regardless of whether the unit is occupied, but that comes with a fee that needs to be kept in mind. We cover how sublease works in more detail in a separate article, How Sublease (Rent Guarantee) Agreements Work, and What to Watch For. Weighing that fee against your fixed costs is an important part of deciding whether self-management, outsourced management, or sublease fits best.
Visualizing Fixed Costs as an Annual Figure
Listing out property tax, insurance premiums, common area fees, and management fees as an annual figure makes it much easier to picture concretely how a vacancy would affect your cash flow. Understanding the relationship between rental income and fixed costs in numbers gives you a foundation for thinking through vacancy countermeasures and financial planning.
Balancing Advertising Costs and Restoration Costs During a Vacancy
Advertising spend to fill a vacancy, and restoration work after a tenant moves out, are additional costs that come alongside fixed costs. Whether it's worth spending that money to secure a tenant sooner, or holding back and taking more time, depends on your fixed-cost level and financial position. For properties with heavier fixed costs, prioritizing a faster resolution to the vacancy is often the more rational call.
Frequently Asked Questions
Does property tax still apply during a vacancy?
Yes. Property tax and city planning tax are due every year as long as you own the property, regardless of whether it's occupied.
How much working capital should I keep on hand if a vacancy drags on?
It depends on the size of the property and the level of fixed costs, but a reasonable benchmark is enough working capital to cover several months of fixed costs and management fees.
Does switching to sublease remove the worry about fixed costs during a vacancy?
Sublease is a way to transfer vacancy risk, but it comes with a fee. You'll need to weigh that against your fixed costs.
Summary
Fixed costs such as property tax, insurance premiums, and common area fees keep accruing during a vacancy. Visualizing them as an annual figure and keeping working capital in reserve with some margin is a realistic way to prepare for a vacancy that runs longer than expected.