Break-even occupancy is the share of a property's potential income you need to collect to cover its operating expenses and loan payments. Collect less and the property costs you money each month.
Break-even occupancy = (operating expenses + debt service) ÷ gross potential income
Gross potential income is the rent the property would collect if fully rented all year. Say a fourplex has four units at $1,250 a month each, or $60,000 a year.Operating expenses run $22,000 a year and loan payments, also called debt service, total $26,000, so the property costs $48,000 a year to carry. $48,000 ÷ $60,000 = 80%. You could lose up to 20% of the potential rent, or $12,000 a year, to vacancy and unpaid rent before the property stops covering its bills. All figures are pre-tax.
The number shows how much room for error a deal has. Compare it with the vacancy rate you expect: a property that breaks even at 80% in a market that runs 5% vacant has a wide cushion, while one that breaks even at 93% has almost none. A common mistake is leaving costs such as management, repairs or a reserve for big replacements out of the expense line, which makes the deal look safer than it is. Check it early on a short-term rental, where bookings swing with the season.