Break-even occupancy
Also called Break-even ratio, Default ratio.
Break-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.
How it works
It answers the question a DSCR does not: how far can this deal fall before it needs money from the owner. DSCR tells you the cushion at the underwritten occupancy. Break-even occupancy converts that cushion into the units that would have to empty out for the cushion to disappear, which is the version a partner or an investment committee can actually hold in their head.
The measure is sensitive almost entirely to leverage. A property with no debt breaks even wherever operating expenses are covered, often somewhere in the thirties. The same property at 65 percent leverage typically breaks even in the high seventies. Adding leverage does not change the building; it moves the trapdoor closer to where the property is standing.
It is also the right measure to run against submarket history rather than against a general vacancy assumption. If the submarket's worst recorded occupancy over the last twenty years is 88 percent and the deal breaks even at 79 percent, that is a specific, checkable statement about downside. A generic 10 percent vacancy sensitivity is not.
Formula
Break-even occupancy = (operating expenses + annual debt service) / gross potential income- Gross potential income is gross potential rent plus other income, before any vacancy deduction
- Include replacement reserves if the property genuinely has to fund them from operations
- During an interest-only period the answer is materially lower than it will be after amortisation begins
Worked example
The sample property with a $36,335,000 loan at a 6.35 percent constant, interest only.
| Operating expenses | $1,708,000 |
|---|---|
| Annual debt service | $2,307,272 |
| Total cash requirement | $4,015,272 |
| Gross potential incomerent $4,870,800 plus other income $198,000 | $5,068,800 |
| Break-even occupancy | 79.2% |
Underwritten occupancy is 93 percent, so roughly fourteen points of cushion, about thirty units. That is the number to compare against what the submarket actually did in its worst year.
The common mistake
Computing it during the interest-only period and forgetting it moves
A loan with three years of interest only and then a thirty-year amortisation schedule has two break-even occupancies, and the second one is higher. On this loan, annual debt service rises from $2,307,272 to $2,713,072 once principal starts, which pushes break-even from 79.2 percent to 87.2 percent and leaves under six points of cushion against the underwritten 93. If the business plan assumed the property would be sold or refinanced before that happens, the break-even calculation is measuring a risk the deal is not actually taking, and the one it is taking is unmeasured.
Related terms
- Debt service coverage ratioThe debt service coverage ratio is net operating income divided by annual debt service. A 1.25x means the property produces $1.25 of income for every $1.00 of principal and interest owed, so net operating income could fall by 20 percent before coverage reaches 1.00x and the loan stops being covered.
- 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.
- Interest-only periodAn interest-only period is a stretch at the start of a loan during which the borrower pays interest and no principal. It raises early cash flow and coverage, and it ends with a step up in debt service that has to be modelled.
- Operating expense ratioThe operating expense ratio is total operating expenses divided by effective gross income. It is a fast sanity check on whether an expense budget is plausible for the asset type, the market and the way the property is run.
- Loan constantThe loan constant is annual debt service divided by the original loan balance, expressed as a percentage. It combines the interest rate and the amortisation schedule into one number, which is what makes it the right rate to compare against a cap rate.
- Cash-on-cash returnCash-on-cash return is a year's cash flow after debt service divided by the total equity invested. It measures the current income yield on the money actually at risk, ignoring appreciation and any eventual sale.
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.