Break-Even Occupancy
The minimum occupancy rate at which a property's income covers all operating expenses and debt service, with no cash flow left over.
Definition
Break-even occupancy tells an owner how far vacancy can rise before a property stops covering its bills. It is calculated by dividing total operating expenses plus annual debt service by potential gross income at full occupancy. A property with a low break-even occupancy has more cushion against vacancy or rent softness. A property with a high break-even occupancy, often the result of aggressive leverage, has little room for error before cash flow turns negative. Lenders review break-even occupancy during underwriting, especially for multi-tenant small bay properties where vacancy is driven by several independent small business tenants rather than a single large lease. A low headline cap rate or cash-on-cash return is less attractive if it comes paired with a break-even occupancy above 85-90%, since that leaves little margin if one or two tenants vacate.
Formula
Break-Even Occupancy = (Operating Expenses + Annual Debt Service) / Potential Gross Income at 100% OccupancyExample
A 12-unit small bay property has potential gross income of $220,000 at full occupancy, operating expenses of $70,000, and annual debt service of $85,000. Break-even occupancy = ($70,000 + $85,000) / $220,000 = 70.5%. The property can drop to roughly 70% occupied, about 3.5 vacant units, before it stops covering expenses and debt.
See Also
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