When Rents Fall: Four Things to Do

Consider that today, as Covid-19 rages, as much as one-half of all multifamily loans under $10M are considering mortgage forbearance.  There is never a government stimulus program for real estate owners; it’s against the competitive assets in your marketplace.

Rental Property Owners Have Zero Pricing Power When Rents Fall

As a rental property owner, when rents fall, like they did in 2009, and will again in 2021, there is limited pricing power to increase rents. When historically high vacancy rates occur, tenants have a selection of properties to choose from; residents have pricing power and demand concessions.

How you address falling rents at the local market level can make or break your rental property business.

Mid-summer 2020 Bloomberg News released this article: The Worst for U.S. Renters and Apartment Owners Is Yet to Come. Here is an excerpt:

One in three renters failed to make their full payment in the first week of July, an Apartment List survey showed. According to an analysis by advisory firm Stout Risius Ross, nearly 12 million renters could see eviction notices in the next four months. And in some cities, like New York and Houston, more than a fifth of renters say they have “no confidence” in their ability to pay next month.

 

rents fall rent sign with arrow

Rental Property Owners Objective: Avoid the F-word

As a rental property owner, if you were yet to have that “oh shit” moment, now is the time. Options available for any real or meaningful forward-looking strategy is moot if the money stops flowing entirely or if 20% vacancy is the norm in major markets.  The F-word to avoid on the minds of every rental property owner: foreclosure.

Whereas many rental property owners focus their attention on price, the price per square foot, such as competition-based on-property amenities, represents a “cut line” for consumers (tenants seeking a place to live).

If the rent amount is the same between two competing assets, which rental property wins their business?  The property winner is the asset with the most relevant amenities and amenities package, representing the best-perceived value for the resident.

Rent growth is often hard-fought. To the casual observer, rent growth is paramount to price gouging – an evil thing.  However, inside the property rental business, rent growth is just barely covering the increased costs of operations.

Have you ever heard of a real estate tax bill or utility bill going down? Did you know that grass-cutters sometimes make $30 an hour? Rent growth is a necessary component of operating a successful rental property of any size.  Profit potential only materializes after diligent budgeting that encompasses both income and expenses.

For real estate investors who haven’t lived through a downturn, it is new knowledge that rents can and do decrease.  Well, yeah.  It may not occur often, but it does happen – and always at the worst possible time, at least it seems that way.

While it’s true that nearly one-third of all real estate assets in the U.S. are free and clear with no mortgage debt, conversely, that means that two-thirds have a mortgage. The funny thing about mortgage payments (maybe you know this) is that they never sleep, never take a break or stop until paid in full.

In the last turndown, something new was corporate investors getting into the single-family home market in a big way. The footprint of these single-family home investment portfolios created a sizable shadow rental market that created competition for multifamily. Single-family homes as rentals were a new wrinkle.

Institutional owners of single-family “for rent” portfolios represented a new player on the field., a new form of direct competition that multifamily owners had to now consider as vying for the same rental dollars. I can imagine this scenario repeating if foreclosures escalate again as banks seek to reduce their burdensome real-estate-owned (REO) single-family portfolios en masse.

To remain competitive in the multifamily rental business requires retaining good tenants along with marketing for new customers.  Marketing and retention should be an absolute focal point of management’s daily efforts; it’s not a weekend-only thing or only for one week a month.

Property managers must know their markets and competitors – no matter their origin. New construction, converted office space, whole single-family newly built subdivisions now for rent – all competitive sources must be considered.

With current tenants (depending on the volatility of your local marketplace), small concessions can go a long way to securing renewals, $100 visa cards, or Starbucks gift cards.

In today’s economy, grocery store gift cards are an appreciated token for their consideration to remain for another lease term.  Offering to clean carpets at renewal time is a mutual benefit that is good for the resident and the property owner.  This small, simple act builds goodwill and assists in maintaining property value by increasing the longevity of in-place flooring.

Taking concessions a step further, in ultra-competitive markets, is to offer in-place residents two-weeks free in exchange for signing a lease extension.  I can hear you bristling now. Harsh, you say?  How hungry is your mortgage for a revenue stream?

In new construction, multifamily carpeting is a vanishing product.  Today, carpet in bedrooms is declining in favor of 20-year vinyl flooring products.  See my article, Carpet, Tile Vinyl, and Wood.

Four Things to Do When Rents Fall

1) Make no assumptions that rents fall is true

Are rents falling?  How do you know?  When rents fall, the most direct method for identifying changes to your local market is market surveillance.   If competing properties can obtain higher rents than your property (competing properties being of similar age and quality), and occupancy levels are identical, determine what concessions or rent concessions your competitors are offering.

The concession has to provide value – people know cheesy when they see it.  Use rent concessions that make sense in your local market; tickets to a Bears game in Chicago.

A few years ago, a free flat-screen TV was a big deal (versus 30 days free rent).  It was the type of premium that may be offered to a quality tenant signing an eighteen-month lease.

Today people are more cash conscious and would likely take the free month or other near-cash equivalents like a $250 Visa or gasoline card.   The economic times are dictating this.   There is no hard science to tell us why a similar unit will rent for $1795 and not $1800- but we all know consumer psychology tells us this is true.

2) Don’t panic!  Focus on rent renewals

Rule number one (but the second thing to do) is to:  Focus on renewals.  Taking care of current customers is the first step towards ensuring vacancy doesn’t rise further.  Every renewal means one less unit on the market. Often, operators focus on rent growth at lease renewal to the detriment of the property.

Rent growth at the expense of higher turnover is a losing game when property vacancy is already rising.  When rental property vacancy hits new highs nationally, individual rental property assets will always lose when turnover increases.

 

3) Determine a marketing strategy

Use the right rent concessions in your marketplace, based on market surveillance, to create incremental increases in revenue.   Here are some examples:

  • Offer two-bedroom units as one-bedrooms by locking off one bedroom, thus, effectively turning the two-bedroom into a one-bedroom.   If your market has an over-supply of two’s, this will buy you some additional occupancy. This idea should represent a small portion of available units while offering just one more method to boost occupancy.
  • In especially hard-hit markets, offer two months free with a fourteen-month lease.  The first and last month of the contract is when to provide the free months to credit-worthy tenants only.
  • Add basic cable for new tenants (for six months).  It’s a concession that burns off over a set amount of time while securing a new tenant today, and the expense is measurable.

 

4) Coordinate your efforts

Ensure that all on-site property managers and off-site personnel are aware of the urgency to focus on full occupancy, reducing vacancy, and the methods deployed to address increasing revenue.   Sometimes this means rotating staff from one site to another to cross-train.  Weekly or monthly staff meetings with “good” refreshments never hurt.  Meetings should be one-hour maximum but well planned to cover specifics.

 

John Wilhoit is the author of the best-selling book on rent roll analysis: How to Read and Rent Roll. See also the companion guide to measuring the quality of rental income: Rent Roll Triangle.  Find JW’s Podcast here.

 

Add Comment