Rent Vacancy Stress Test

Drop occupancy from your market assumption (95%+) down to 90% across the entire ten-year hold. This stress test separates properties that survive occupancy declines from those that break under recessionary pressure.

Key takeaways

• The "rent vacancy" stress test assumes 90% occupancy instead of market occupancy (typically 92–96%)
• A recession often drives occupancy down 5–10 percentage points, so 90% is a realistic downside scenario
• Run the full pro forma at 90% occupancy and check: (a) annual cash flows stay positive, (b) year-10 equity proceeds remain acceptable
• Properties that survive 90% occupancy stress are resilient; those that don't are vulnerable to economic cycles
• This test reveals whether your deal depends on optimistic occupancy assumptions

The impact of 5% occupancy loss

A 5-percentage-point drop in occupancy (from 95% to 90%) cuts gross effective income by 5%. For a $1 million property at 5% cap rate (yielding $50,000 NOI), effective income is $100,000. At 95% occupancy, you collect $95,000 after vacancy loss. At 90%, you collect $90,000.

The $5,000 difference doesn't sound large, but it's 10% of your NOI. If debt service is $45,000 and you had $5,000 in annual cash flow at 95% occupancy, at 90% you have $-5,000 (negative cash flow).

Worked example: the 50-unit multifamily

Base case assumptions:

• 50 units at $1,200/month rent = $720,000 potential income
• Market occupancy: 95% (reasonable for a stabilized property in a growing market)
• Effective income: $684,000
• Operating expenses (35% of ERI): $239,400
• NOI: $444,600
• Debt service: $325,000 (on 60% LTV financing)
• Annual cash flow to equity: $119,600
• Equity cash-on-cash: $119,600 / $720,000 (down payment) = 16.6%

Stress case assumptions (90% occupancy):

• 50 units at $1,200/month = $720,000 potential
• Occupancy: 90% (recession scenario)
• Effective income: $648,000
• Operating expenses (35% of ERI): $226,800
• NOI: $421,200
• Debt service: $325,000 (fixed)
• Annual cash flow to equity: $96,200
• Equity cash-on-cash: 13.4%

The 5-percentage-point occupancy drop reduces cash-on-cash return from 16.6% to 13.4%—still positive, still decent. This property is resilient.

Now consider an overleveraged scenario:

• Same property, but leveraged at 75% LTV instead of 60%
• Down payment: $180,000 (25% on $720,000 value)
• Debt: $540,000 at 5.5%, 30-year
• Debt service: $381,000 annually
• Base case (95% occupancy): NOI $444,600 − Debt Service $381,000 = Cash Flow $63,600
• Stress case (90% occupancy): NOI $421,200 − Debt Service $381,000 = Cash Flow $40,200

Still positive in the stress case, but the margin has compressed from $63,600 to $40,200 (36% decline). If you stress further—to 85% occupancy—the property goes negative.

A third scenario: extreme leverage at 80% LTV:

• Down payment: $144,000
• Debt: $576,000 at 5.5%
• Debt service: $406,000
• Base case: NOI $444,600 − DS $406,000 = $38,600
• Stress case (90% occupancy): NOI $421,200 − DS $406,000 = $15,200

The stress case margin is razor-thin. A further 2–3% occupancy decline turns the deal negative. This deal is vulnerable.

When 90% occupancy happens: real-world precedent

2008–2009 financial crisis: Multifamily occupancy fell from 94–95% to 87–90% in major metros over 12–18 months. Secondary markets saw 80–85% occupancy.

2001 recession: Office occupancy fell to 85–90% in major metros; apartments held at 90–93%.

COVID-19 (March–September 2020): Retail dropped to 40–50% occupancy (temporarily). Hospitality crashed. Multifamily, surprisingly, held at 92–94% occupancy even as unemployment spiked to 14% (because of eviction freezes and forbearance programs).

2023–2025 current market: Multifamily occupancy is 94–96% in strong metros, 88–92% in weak metros. If the economy falls into recession, 90% occupancy is a reasonable downside case. If it's severe, 85% is possible.

The 90% occupancy stress test, therefore, isn't pessimistic—it's a realistic recession scenario.

Building the stress case: methodology

1. Start with base case pro forma at market occupancy (95%, 92%, whatever you assumed).
2. Copy all assumptions except occupancy.
3. Set occupancy to 90% across all ten years.
4. Recalculate effective income in year 1 (and each year):
   • Effective Income = Potential Income × 0.90
5. Recalculate NOI using the lower effective income.
6. Keep debt service unchanged (it's fixed by the loan).
7. Recalculate annual cash flow and cumulative equity cash flows.
8. Recalculate levered IRR for the ten-year hold.

Interpreting the results

Outcome A: Stress case delivers 80%+ of base case IRR

• Base case 14%, Stress 11.5%. The property is resilient; a occupancy decline hurts but doesn't break it.

Outcome B: Stress case delivers 60–80% of base case IRR

• Base case 14%, Stress 9%. Moderate sensitivity. The property works in the base case but is vulnerable to sustained occupancy decline.

Outcome C: Stress case delivers <60% of base case IRR

• Base case 14%, Stress 7%. High sensitivity. The deal is overleveraged for occupancy risk.

Outcome D: Stress case annual cash flow turns negative

• Base case $50k/year, Stress −$10k/year. Red flag. The property can't cover debt service at 90% occupancy. Walk, or dramatically reduce leverage.

The correlation with leverage

The stress test reveals how leverage amplifies occupancy risk:

• All-cash deal: 5% occupancy loss reduces returns by ~5% (proportional).
• 50% leverage (LTV): 5% occupancy loss reduces returns by ~7–8% (amplified, because losses concentrate on smaller equity).
• 70% leverage (LTV): 5% occupancy loss reduces returns by ~12–15% (highly amplified).
• 80%+ leverage (LTV): 5% occupancy loss can turn positive cash flow negative.

This is why overleveraged properties are so dangerous in recessions: occupancy risk is magnified.

The occupancy-rate-growth tradeoff

In the stress case, do you model the same rent growth (3% annually) as the base case? This is where judgment matters:

• Conservative approach: Assume 0% rent growth during the stress period. Rents stay flat at year-1 level.
• Realistic approach: Assume 1–2% rent growth even in the stress case (long-term inflation continues). But occupancy stays at 90%.
• Base case approach: Assume 3% rent growth and 95% occupancy.

The most common error: running the stress case with full rent growth (3%) and lower occupancy (90%). This conflates scenarios. If occupancy is down 5 points due to recession, rents are probably not growing 3%.

A more realistic stress case: 90% occupancy + 0–1% rent growth.

Additional operational stress: combined shocks

Some analysts push further and combine stresses:

Scenario A: "Occupancy decline only" — 90% occupancy, normal rent growth, normal expense growth.

Scenario B: "Recession stress" — 90% occupancy, 1% rent growth, 5% expense growth (wages rise as unemployment falls, but slower income growth).

Scenario C: "Extended downturn" — 85% occupancy, 0% rent growth, 6% expense growth.

Scenario D: "Severe recession" — 80% occupancy, -1% rent decline, 6% expense growth.

Most professional underwriters use Scenario A (90% occupancy only) as "the" stress test, because it isolates occupancy risk. Scenarios B–D are additional stress cases for very conservative underwriting or high-risk properties.

When occupancy stress reveals a deal-breaker

Walk away if:

1. Stressed case cash flows go negative and stay negative (not just in one year, but sustained). The property can't cover debt service under stress.

2. Stressed case IRR falls below 6–7%. At that level, the property is barely worth holding. A small additional shock (rate hike, cap rate expansion) wipes out returns.

3. Stressed case equity proceeds are negative (you owe money at exit even after sale). This happens when leverage is extreme and occupancy decline erodes all equity gains.

4. Debt service coverage ratio (NOI / Debt Service) falls below 1.0 in stress case. This means the property doesn't cover its debt obligations.

Case study: the 2008 crisis

A property purchased in 2006 with these assumptions:

• Base case: 95% occupancy, 4% NOI yield, 60% LTV, annual cash flow positive
• Stress test (90% occupancy): still positive cash flow, IRR only down 20%

In reality, by 2009:

• Actual occupancy: 87%
• NOI yield: fell below 3% (due to rent declines)
• LTV: underwater (property value fell 30%, debt stayed constant at 60% of original purchase price)

The property crashed because the combination of occupancy decline, rent decline, and price decline exceeded the stress test. The lesson: stress tests with only one variable (occupancy alone) miss cascade risks.

Still, the 90% occupancy test would have revealed the deal's sensitivity. A property that required 95% occupancy to be viable (broke even at 90%) should have raised red flags in 2006.

Occupancy stress test flowchart

Related concepts

• Break-Even Occupancy
• The Pro Forma Spreadsheet
• Return on Equity (ROE)

Next

Occupancy and rents are operational risks; interest rates are a financial risk. The next stress test raises debt costs by 200 basis points to simulate a refinancing into a higher-rate environment.