Bad debt and credit loss
Also called Bad debt, Credit loss, Delinquency.
Bad debt is contracted rent that was billed and never collected. It is deducted alongside vacancy on the way to effective gross income, and unlike vacancy it does not resolve when the unit is leased, because the unit is already leased.
How it works
The two are combined into a single vacancy and credit loss line on most summary pages, and the combination hides the only thing worth knowing about them. Vacancy is a leasing problem, solved by filling units. Bad debt is a screening and collections problem, solved by changing who is allowed to sign and how quickly a balance is pursued. A property can have a great leasing team and a terrible rent roll.
The reported percentage also depends on a policy rather than on performance. Bad debt is recognized when a balance is written off, and write-off policies differ by months, so two properties collecting identically can publish different numbers. The delinquency aging report is the document that settles it, because a balance more than sixty days old is a write-off that has not happened yet.
Expectations vary with the jurisdiction more than most operating assumptions do. Eviction timelines are set by courts, not by the business plan, and a market where the process takes nine months carries a structurally higher credit loss than the same property in a market where it takes six weeks. That difference is a fact about the location and it belongs in the underwriting rather than in a footnote.
Formula
Bad debt = rent billed - rent collected, on occupied units- Vacancy is rent lost because nobody is in the unit; bad debt is rent lost with somebody in it
- Concessions are neither: they are rent that was never billed
- The write-off policy sets the timing, so compare aging schedules rather than reported percentages
Worked example
220 units, gross potential rent at in-place rent of $4,870,800, and a combined vacancy and credit loss deduction of 7.0 percent on both.
| Property A vacancy at 6.0% | ($292,248) |
|---|---|
| Property A bad debt at 1.0% | ($48,708) |
| Property B vacancy at 3.0% | ($146,124) |
| Property B bad debt at 4.0% | ($194,832) |
| Combined deduction, either way | ($340,956) |
| Same deduction, different asset | one is a leasing problem, one is a tenant base |
Property A fills thirteen units and the deduction largely goes away. Property B is 97 percent occupied and collecting 96 percent of what it bills, which is a rent roll that has to be turned over before the income is real.
Conventions worth knowing
- Ask for the delinquency aging report rather than the bad debt percentage. Balances over sixty days are what becomes a write-off.
- A property carrying delinquent tenants as occupied is reporting an occupancy it does not have. Read the balance column against the status column on the rent roll.
The common mistake
Underwriting bad debt away on day one
New ownership almost always improves collections and almost never improves them immediately. Evictions run on timelines set by courts, replacement tenants take a further sixty to ninety days, and the units involved are the ones needing the most turn work. A model that drops bad debt from 4 percent to 1 percent in year one is assuming a full turnover of the delinquent share of the rent roll inside twelve months at no cost. Phase it across two years, and put the turn cost and the downtime of every displaced unit in the capital budget where they belong.
Related terms
- Economic versus physical occupancyPhysical occupancy is the share of units that are occupied. Economic occupancy is the share of potential rent that is actually collected. The gap between them is everything that stops an occupied unit from paying full rent: loss to lease, concessions, bad debt, employee units and down units.
- Effective gross incomeEffective gross income is all the revenue a property is expected to collect in a year: gross potential rent, less vacancy, loss to lease, concessions and bad debt, plus other income. It is the revenue figure operating expenses are subtracted from to reach net operating income.
- Concessions and free rentA concession is rent given away to sign or renew a lease, most often as free months at the start of the term. It is a deduction on the way from gross potential rent to effective gross income, and it is what separates the asking rent on a rent roll from the rent a tenant actually pays.
- Rent rollA rent roll is the unit-by-unit or tenant-by-tenant schedule of who occupies a property, what they pay, and when their lease ends. It is the primary evidence behind every revenue assumption in an underwriting model.
- Break-even occupancyBreak-even occupancy is the occupancy level at which a property's collections exactly cover its operating expenses and debt service, with nothing left over. Below it, the property consumes cash instead of producing it.
Every figure, traced to its source
Altyst computes these in exact decimal arithmetic, not with a language model, and clicking any number shows the formula behind it.