Why Cash Flow Depends on the Tenant Segment

A rental property is no better than the tenant who occupies it.

[Photo by Lukas Blazek on Unsplash]

A rental property is only as good as the tenant who occupies it. If the tenant doesn't pay rent or the unit is vacant, you don’t receive any income. So, the only way to have a reliable income is if the property is continuously occupied by a reliable tenant. I define a reliable tenant as someone who stays many years, pays the rent on schedule, and takes care of the property. Reliable tenants are the exception, not the norm.

Some people believe that the population of renters is homogeneous and that all tenants have the same behavioral characteristics. However, this is not true. The population of renters is actually a collection of multiple tenant segments, as illustrated below.

For instance, there are three major tenant segments in Las Vegas. The following list shows the segment’s average length of stay. I chose the name of each segment based on how long they stayed in the property.

• Transient: <1 Year

• Permanent: >5 Years

• Transitional: <2 Years

Properties that target Transient or Transitional tenants will experience more frequent periods of vacancy than those that target Permanent tenants. The cost of each vacancy is the sum of all costs incurred from the time a tenant vacates until a paying tenant is back in the property. The primary cost components of each vacancy include:

• Time to rent

• Carrying costs (debt service, insurance, taxes, utilities, etc.)

• Cost to renovate the property between tenants.

Below are the typical per-vacancy cost and annual vacancy cost for each of the three tenant segments in Las Vegas.

The formula for cash flow: Cash Flow = Rental Income - Recurring Expenses.

The issue with this formula is that it does not consider vacancy cost. To include vacancy cost, use the tenant segment-specific formulas below.

• Transient Cash Flow = Income - Recurring Expenses - $6,921

• Permanent Cash Flow = Income - Recurring Expenses - $561

• Transitional Cash Flow = Income - Recurring Expenses - $4,845

What is the cash flow difference between a Transient property and a Permanent property?

A Transient property must generate $6,351 ($6,912- $561) more per year to have the same cash flow as a Permanent property.

This is why your cash flow depends upon the tenant segment the property targets.