How does vacancy rate affect a property's Net Operating Income (NOI), and what is a typical vacancy assumption used in underwriting?

NOI is calculated as effective gross income (potential gross rent minus vacancy and credit losses) minus operating expenses. If a property has $50,000 in potential annual rent and you apply a 5% vacancy factor, effective gross income drops to $47,500. Even seemingly small vacancy rates have a significant impact on NOI and thus cap rate. Vacancy assumptions should reflect local market data; a strong urban market might justify 3% to 5% while a rural area might require 10% or more. Most experienced underwriters also add a separate credit loss assumption of 1% to 2% to account for non-paying tenants.