The vacancy rate is one of the most important indicators of the health of the rental property market. The vacancy rate is the percentage of the total space in the market under consideration that is vacant.
For example, let’s say that we have data as of the end of June 2011 for the rental office space market in metropolitan area X indicating that there are 200,000 square feet of vacant office space in a total rental office space stock (in contrast to owner- occupied office space)of 2,000,000 square feet. Then the vacancy rate (V) can be calculated as:
V = 200,000/2,000,000 =10%
In the case of rental housing or apartments, usually the total stock and the vacant stock are expressed in units. The formula though is the same. If for example we have 20,000 vacant units in a market with an existing stock of 200,000 rental housing units, then V can be calculated as follows:
V = 20,000/200,000 =10%
V is an indicator of the health of the rental market because it actually represents the difference between the demand and supply in the market. The demand is represented by the occupied stock and so the vacant stock represents excess supply. Is that right? Not exactly. According to a number of academic papers on the topic, the market is not at equilibrium when the vacant stock and therefore V is zero, but when V has a positive value that represents the vacant stock required to accommodate the time-consuming search of tenants for space and landlords for tenants. Due to the high heterogeneity of property in terms of quality and location, tenants typically inspect several properties and locations in order to choose the one that best satisfies their needs at a price they can pay. For this reason, proper search on the part of the tenants requires the availability of sufficient vacant stock that will allow them to conduct a reasonable search. This stock is referred to as structural vacant stock and as percent of total stock as structural vacancy rate.
Within this context, the rental market is at equilibrium when V is equal to the structural vacancy rate. If it is below that it signifies supply shortage and rents must be rising. If the nominal vacancy rate is above the structural one then rents must be declining