physical_occupancy

• The Bottom Line: Physical occupancy is the ultimate reality check for a property's health, measuring how many tenants are actually in the building and operating, not just how many have signed a lease.
• Key Takeaways:
• What it is: The percentage of a property's total rentable space that is currently physically occupied by a tenant.
• Why it matters: It reflects a property's immediate, real-world cash flow generation, cutting through the optimism of future-dated leases and providing a more conservative view of performance than its cousin, economic_occupancy.
• How to use it: Use it as a sanity check to gauge the true operational stability of a property or reit and to build a proper margin_of_safety into your valuation.

Imagine you own a popular restaurant. You look at your reservation book for Saturday night and see that every single table is booked. This is your “leased occupancy”—100%. On paper, you're set for a fantastic night. Now, imagine it's 8 PM on Saturday. You look out at the dining room. You see that most tables are full of happy customers, but three tables in the corner are empty. The people who booked them haven't shown up yet, or perhaps they've just signed a corporate contract to host a dinner next month. The tables that have people actually sitting in them, ordering food and drinks right now, represent your physical occupancy. In the world of real estate investing, physical occupancy is that real-time snapshot of the “dining room.” It's not about the promises of future rent (the reservations); it's about the tangible reality of who is using the space and contributing to the property's cash flow today. While economic_occupancy (also called leased occupancy) tells you how much space has a signed lease agreement on it, physical occupancy tells you how much of that space is actually in use. A tenant might sign a lease for a new office but not move in for six months while the space is being customized. During those six months, the economic occupancy is high, but the physical occupancy for that space is zero. For a value investor, this distinction is not just academic—it's the difference between a promise and a paycheck.

“The first rule of investing is not to lose money. The second rule is not to forget the first rule.” - Warren Buffett

This principle is at the heart of why physical occupancy matters. By focusing on the tangible, present reality of a property's usage, an investor adheres to a discipline of conservatism and avoids paying for future growth that has not yet materialized.

For a value investor, investing is about buying a stream of predictable, durable cash flows at a reasonable price. Physical occupancy is a critical metric because it provides a clear, unvarnished look at the source of those cash flows. Here's why it's a cornerstone of real estate analysis through a value investing lens:

• It's a Measure of Reality, Not Hype: Management teams love to announce major new lease signings. It sounds great in a press release and can boost short-term stock sentiment. But a value investor is a business analyst, not a market speculator. A 100,000-square-foot lease signed with a blue-chip company is exciting, but if that tenant doesn't start paying rent or occupy the space for another 18 months, it contributes nothing to the intrinsic_value of the business today. Physical occupancy grounds your analysis in the current cash-generating power of the asset.
• It Reinforces the Margin of Safety: The great value investor Benjamin Graham taught that a margin of safety is the secret to sound investment. When you value a Real Estate Investment Trust (reit), you are projecting its future Net Operating Income (NOI). If you base your valuation on a reported 97% leased occupancy but fail to notice that the physical occupancy is only 89%, you have overestimated current NOI. You are paying for income that doesn't exist yet. By basing your valuation on the more conservative physical occupancy figure, you are building in a buffer. You are paying for what is, not what might be.
• It's a Canary in the Coal Mine: A significant and growing gap between physical and economic occupancy can be a powerful warning sign. Why are tenants signing leases but delaying their move-ins?
  • In an office building, it could signal that tenants are uncertain about their own business prospects and are putting off the expense of a physical move.
  • In a new apartment complex, it might mean the landlord offered huge concessions (like three months of free rent) to inflate their “leased” numbers, and the building isn't truly as in-demand as it appears.
  • In a retail center, it could mean a new anchor store is taking a very long time to build out its space, delaying the foot traffic that smaller tenants rely on.

A value investor uses this gap as a signal to start asking tough questions. They are not satisfied with the headline number; they want to understand the story behind it.

The formula for physical occupancy is straightforward and focuses on tangible square footage. `Physical Occupancy % = (Total Physically Occupied Square Footage / Total Rentable Square Footage) * 100` Let's break it down:

• Total Physically Occupied Square Footage: This is the sum of the square footage for all units or spaces where a tenant is physically present and operating. This space is “live.”
• Total Rentable Square Footage: This is the entire amount of space in the property that is designed to be leased out to tenants.

It is crucial to differentiate this from the formula for economic occupancy, which uses leased square footage in the numerator.

A number by itself is useless. The real skill lies in interpreting what the physical occupancy rate, and its relationship with economic occupancy, tells you about the investment.

• High Physical Occupancy (e.g., 95%+): This generally indicates a stable, healthy, and desirable property. It suggests strong demand and consistent cash flow. For mature assets like grocery-anchored shopping centers or well-located apartment buildings, you want to see this.
• Low Physical Occupancy (e.g., <85%): This is a red flag that warrants deep investigation. It could be due to a variety of factors, from a weak local economy and poor management to the property being in a “lease-up” phase after construction.
• The Critical Gap (Physical vs. Economic): The most insightful analysis comes from comparing the two occupancy types.
  • Small Gap (e.g., Physical 94%, Economic 95%): This is normal and healthy. It reflects typical tenant turnover, where a new tenant is about to move into a space that a previous one just vacated.
  • Large Gap (e.g., Physical 80%, Economic 95%): This is where you must put on your detective hat.
    • Is it a new building? If so, a large gap is expected and even desirable. It shows management is successfully pre-leasing space before construction is even finished. This is a sign of strong future growth.
    • Is it a mature building? If so, this is a major concern. It suggests tenants have signed leases but are not moving in. This could be due to tenant financial distress, delays in their own business plans, or landlord-offered incentives that artificially boost the leased rate. This situation poses a risk to near-term cash flow.

Let's compare two hypothetical apartment REITs to see how physical occupancy provides crucial context. Both own a single, 200-unit apartment building where each unit is 1,000 square feet (Total Rentable Area = 200,000 sq. ft.).

On the surface, looking only at the press-release-friendly metric of economic occupancy, both properties look identical at 95%. A superficial analysis might conclude they are equally strong investments. However, the value investor digs deeper.

• The Foundation Apartments: This is a stable, mature asset. The tiny 1% gap between economic and physical occupancy is perfectly normal. It likely represents one or two units where the old tenant has moved out and the new tenant is moving in next week. The property's cash_flow is strong and predictable. This is a classic, stable performer.
• The Ascend Lofts: This is a brand-new building that just opened. The 15% gap between economic and physical occupancy tells a story of a successful “lease-up.” The management team has done a fantastic job securing tenants before the building was even ready. While its current cash flow is lower (based on the 80% physical occupancy), its trajectory is strongly positive. An investor here is buying into visible, near-term growth as the remaining 30 leased tenants move in over the coming months. The risk is that some of these tenants might back out, but the high lease rate is a very encouraging sign.

The key takeaway is that physical occupancy forces you to understand the story and context behind the numbers, which is the essence of intelligent investing.

• A Dose of Reality: It provides a conservative, “boots-on-the-ground” measure of a property's current operational health.
• Direct Link to Cash Flow: Physical occupancy is more closely correlated with current rental revenue than any other occupancy metric.
• Early Warning System: A widening gap between physical and economic occupancy in a mature portfolio can signal underlying economic weakness or tenant distress.
• Aligns with Conservatism: Its focus on the present fits perfectly with the value investing ethos of prioritizing proven performance over speculative promises.

• Can Be a Lagging Indicator: In a “lease-up” scenario of a new property, a low physical occupancy rate can mask incredibly strong forward demand and future growth.
• Context is Everything: The number is meaningless without understanding the “why” behind it. An 85% physical occupancy rate can be a sign of success for a new building or a sign of failure for an old one.
• Doesn't Reflect Tenant Quality: A building could be 100% physically occupied, but if the tenants are on short-term leases or are not financially sound, the risk is much higher than a 95% occupied building with blue-chip tenants on long-term leases. Always analyze it alongside metrics like weighted_average_lease_term (WALT).
• Can Be Temporarily Distorted: A large tenant moving out can cause a temporary, sharp drop in physical occupancy. It might be quickly re-leased, but the snapshot in time will look poor.

• economic_occupancy: The essential counterpart to physical occupancy; measures leased space, not occupied space.
• reit: The most common investment vehicle for gaining exposure to large-scale real estate portfolios where this metric is critical.
• net_operating_income: The key profitability metric for properties, which is directly driven by occupancy and rental rates.
• funds_from_operations: A primary measure of a REIT's cash flow, heavily influenced by the real-world performance indicated by physical occupancy.
• margin_of_safety: Using the more conservative physical occupancy figure is a practical way to build this into your real estate valuations.
• weighted_average_lease_term: Provides crucial context on the stability and duration of the existing occupancy.
• cash_flow: Physical occupancy is a direct proxy for the current, tangible rental income that forms the basis of a property's cash flow.