Economic vs Physical Occupancy in Real Estate

Occupancy Formulas

Both formulas are simple, but they answer fundamentally different questions.

Physical Occupancy

Economic Occupancy

Example: A 200-unit property with 190 occupied units, GPR of $300,000/month, and actual collections of $264,000/month.

Why Economic Occupancy Matters More for Underwriting

Economic occupancy directly determines NOI, which drives property valuation. A property can show 95% physical occupancy while collecting only 88% of potential revenue, creating a 7-point gap that translates directly to lower cash flow.

Lenders underwrite to economic occupancy because it reflects the income available to service debt. A lender does not care that a unit is occupied if the tenant is not paying. Similarly, investors should model economic vacancy (the inverse of economic occupancy) rather than physical vacancy when projecting returns.

When a seller quotes "95% occupancy," always ask whether that is physical or economic. The distinction can be worth hundreds of thousands of dollars in annual income.

When Physical and Economic Occupancy Diverge

Four common situations create a gap between the two metrics.

Concessions

Concessions like free rent months mean a unit is physically occupied but generating zero revenue for that period. In lease-up or competitive markets, heavy concessions can push economic occupancy 3 to 5 points below physical occupancy.

Bad debt and delinquencies

Tenants who occupy a unit but do not pay rent create a direct gap. Bad debt typically runs 1% to 3% of GPR in a healthy market, but can spike to 5% or higher in distressed situations.

Model, employee, and down units

Model units used for leasing tours and employee units for on-site staff are physically occupied but produce no revenue. Down units undergoing renovation are neither physically nor economically occupied. All three reduce economic occupancy.

Below-market leases

Long-term tenants on legacy leases pay below current market rates. Their units are physically occupied and generating revenue, but the income falls short of GPR. This effect is captured separately as loss to lease, which feeds into the economic occupancy calculation.

Occupancy Benchmarks by Asset Type

Benchmarks based on NMHC research and Fannie Mae survey data. Ranges vary by market and cycle.

Occupancy Warning Signs in Due Diligence

Certain occupancy patterns should trigger deeper investigation during due diligence. These signals often reveal problems that are not apparent from summary metrics alone.

• Physical above 97%. Occupancy this high usually means rents are below market. The property is leaving revenue on the table, which can be an opportunity for buyers who plan to push rents.
• Economic more than 5 points below physical. This spread signals heavy concessions, significant bad debt, or a large number of non-revenue units. Drill into the rent roll to identify the specific cause.
• Rapid occupancy decline. A property dropping from 95% to 88% physical occupancy in two quarters suggests a property-specific or market-level problem. Check for new competitive supply, management changes, or deferred maintenance.
• Seasonal volatility above 10 points. Some properties in college towns or seasonal markets swing dramatically. Underwrite to the trough, not the peak.

How to Improve Economic Occupancy

Closing the gap between physical and economic occupancy is one of the fastest ways to increase NOI without adding units or raising rents.

• Reduce concessions. If the market supports it, phase out free rent offers and compete on amenities or service instead.
• Tighten screening criteria. Better tenant screening reduces bad debt by filtering out applicants with poor payment histories.
• Accelerate collections. Implement online payment, automatic late fees, and prompt follow-up on delinquencies.
• Convert non-revenue units. Re-evaluate whether model units, office units, and employee units are generating enough value to justify the lost rent.

Each point of economic occupancy improvement translates directly to additional NOI. On a property with $1,000,000 GPR, each percentage point is worth $10,000 per year, or roughly $166,000 to $200,000 in property value at a 5% to 6% cap rate.

Occupancy in Your Pro Forma

In a standard pro forma, economic vacancy (100% minus economic occupancy) captures the full income reduction from physical vacancy, concessions, and bad debt combined. Some underwriters break these into separate line items for clarity.

Always verify the rent roll to distinguish between physical and economic metrics. The offering memorandum may quote physical occupancy prominently while burying economic figures in the financial appendix. Reviewing the actual rent roll data is the only way to calculate true economic occupancy.

Tools like Primer can extract both physical and economic occupancy data directly from rent rolls, automatically calculating the gap and flagging properties where the spread exceeds market norms. This automated analysis saves hours of manual rent roll review on each deal.

Worked Example: Calculating the Occupancy Gap

Consider a 150-unit multifamily property with the following characteristics.

This 6.6-point gap represents $25,500 per month ($306,000 annually) in lost income relative to GPR. At a 5.5% cap rate, closing even half of this gap would create over $2.7 million in property value.

This worked example illustrates why economic occupancy is the metric that drives underwriting decisions. The physical occupancy of 95.3% looks healthy, but the economic occupancy of 88.7% reveals meaningful income leakage that must be addressed in the business plan.

When presenting this analysis to an investment committee, always show both metrics side by side with the dollar impact of the gap. This clarity prevents assumptions from going unchallenged and ensures the underwriting reflects true cash flow potential.