Vacancy and Bad Debt Allowances: The Line Investors Set Too Low

Why the vacancy and non-collection lines in a Saudi property model are usually wrong, what each error costs, and how to set both allowances from the building's own record.

Vacancy allowance is the share of potential rent you expect to lose to empty units. Bad debt allowance is the share you expect to bill and never receive. They are different risks with different causes, and collapsing them into one optimistic percentage is among the most reliable ways to turn a sound purchase into a disappointing one. These are the errors that recur, and what each one actually costs.

Why these keep happening

The underlying cause is that both lines are deductions from a number the buyer wants to be large, and neither is forced on them by any document. A lease sets the rent, an invoice sets a cost, but nobody hands you your vacancy assumption. So it gets set by mood: confident buyers in a rising market write a small number, and the model obediently produces the answer they hoped for. The discipline is to derive both lines from evidence that exists independently of your enthusiasm.

1. Assuming full occupancy because the building is full today

A fully let building at the point of sale tells you about the present, not about the holding period. Leases expire, tenants relocate, employers move staff, and the unit that let in a week last year may take three months next year. A model with no vacancy line is not forecasting stability; it is forecasting that nothing will ever change, which no building has ever delivered over a five-year hold.

• Avoid it by: Derive a vacancy allowance from the building's own letting history over at least two years, unit by unit, counting actual void days rather than asking whether the building was broadly full.
• Proof it is closed: A table of void days by unit for the last twenty-four months, reconciled to the contract start dates you verified.

What it costs you: One unit empty for three months in a ten-unit block removes roughly two and a half per cent of annual rent, and the costs continue throughout.

2. Treating vacancy and bad debt as the same line

An empty unit and a non-paying tenant produce similar damage to income but respond to completely different management actions. Vacancy is a letting and pricing problem solved by marketing, unit condition and realistic rent. Non-collection is a screening and enforcement problem solved by tenant selection, deposits, payment structure and process. Merging them hides which problem you actually have and therefore which remedy to fund.

• Avoid it by: Show two separate lines with separate justifications, and track them separately once you own the asset.
• Proof it is closed: Monthly reporting that splits potential rent lost to voids from potential rent lost to arrears.

What it costs you: A year of managing the wrong problem, during which the real cause continues untouched and the allowance keeps being breached.

3. Ignoring the payment pattern when assessing collection risk

Where rent is paid in a small number of large instalments, a single missed payment is not a minor slippage but a substantial share of the annual income for that unit, and the gap between the missed date and any resolution can be long. A model built on smooth monthly receipts understates both the size of a non-collection event and the working capital needed to absorb it while costs continue.

• Avoid it by: Model receipts on the actual contractual payment dates, then look at the lowest cash balance in the year rather than the annual total.
• Proof it is closed: A monthly cash profile for the first two years showing the minimum balance and the buffer that covers it.

What it costs you: A cash shortfall large enough to interrupt a distribution or a debt payment even though the annual income statement still looks acceptable.

4. Using one allowance across unit types and tenant types

A large family villa, a studio aimed at single professionals, a ground-floor shop and an office suite have different letting depth, different average tenancy lengths and different collection profiles. Applying a single percentage across a mixed building averages away exactly the information you need, and the risk usually sits concentrated in one category rather than spread evenly.

• Avoid it by: Set an allowance per unit category, informed by how long each type took to let historically and how its tenants paid.
• Proof it is closed: A rent roll grouped by category with void days and arrears shown for each group.

What it costs you: A mispriced building where the strong units subsidise a category you would not have bought on its own.

5. Forgetting that costs do not fall when a unit empties

Investors instinctively reduce income for vacancy but leave the cost schedule untouched, or worse, assume costs fall proportionally. In practice management fees on collections fall slightly, while common area utilities, insurance, servicing, security and compliance continue in full, and the empty unit generates its own spending on cleaning, repair and marketing. Vacancy is therefore more expensive than the lost rent alone.

• Avoid it by: Model voids with the cost schedule held flat and a named re-letting cost per turnover added on top.
• Proof it is closed: A worked void calculation showing lost rent plus continuing costs plus re-letting spend for one unit.

What it costs you: An understatement of the real cost of a void by a meaningful margin on every unit turnover.

6. Taking the seller's word on arrears

A rent roll shows what tenants owe, not what they pay. Sellers preparing an asset for sale have every reason to present contracted rent as collected rent, and a tenant in arrears may remain on the roll at full rent while paying irregularly or not at all. Without matching receipts to contracts, you are buying a document rather than an income stream.

• Avoid it by: Reconcile at least twelve months of actual receipts against the contracts, tenant by tenant, and ask directly about any contract with an irregular pattern.
• Proof it is closed: A reconciliation schedule signed off by whoever had access to the collection records.

What it costs you: Inheriting an arrears position, a dispute, or a tenant who leaves shortly after completion and takes the income with them.

7. Setting the allowance after the price is agreed

Once a price is agreed, every assumption in the model comes under quiet pressure to justify it. Vacancy and bad debt are the easiest lines to adjust because nothing external constrains them, so they absorb the gap between the price and the evidence. The result is a model that validates a decision already taken rather than one that tested it.

• Avoid it by: Fix both allowances, in writing, before you make an offer, and treat any later change as a reason to revisit the price rather than the model.
• Proof it is closed: A dated assumptions note issued before the offer, with any subsequent amendment logged and explained.

What it costs you: A purchase at a price the evidence never supported, with the error invisible until the first bad year.

A short check before you sign

• Both allowances appear as separate, labelled lines rather than inside a single occupancy assumption.
• Each is supported by this building's own history, with the source and period stated.
• The allowance differs by unit category where the building contains more than one type.
• The cost schedule stays flat when units are modelled as empty, and re-letting costs are added.
• Receipts have been reconciled to contracts for at least twelve months.
• The assumptions note predates the offer and any change to it is versioned.

If it has already happened

If you already own an asset where these lines were set optimistically, start by measuring rather than reforecasting. Record void days and arrears by unit for a full quarter, split the loss between letting failure and collection failure, and fix whichever is larger with a specific action: a changed rent, an improved unit specification, a different payment structure or a firmer renewal process. Then rebuild the allowance from your own measured record and reset the distribution expectation honestly with anyone relying on it. Local requirements around tenancy registration and enforcement are revised periodically, so confirm the current process before relying on a remedy you used before.

Domira builds the numbers on a Saudi property with you before you commit: rent and cost evidence, condition and capital expenditure, the appraisal and the sensitivities that decide whether the deal survives a bad year. The investment decision stays yours, and so does the advice of your licensed tax and legal advisers.