Rent growth is like compound interest: it grows from a baseline of (rental) income already in hand but requires an up–front investment. With income property there are dozens of potential income sources, but at the end of the day with any income property more than 90% of revenue comes from rents. Thus, growth in rents drives higher revenue the fastest.
Rent growth comes from new and existing leases or from units that are vacated and upgraded to create freshness or differentiation to capture additional rent.
For example: Is there a big difference between current rents and potential rents if you were to perform complete remodels? If the answer is yes, then you will want to know, and measure, the return on investment prior to making this investment in redevelopment.
Rent growth measures take into account dramatic occurrences or intentional causes that management or ownership implement on a property, allowing you to measure potential significant changes in rental income based on changes in operational occurrences.
Consider the following cost versus benefit example: if a $100,000 investment in upgrades will generate $120,000 in annual rent growth that is a great investment. If a $500,000 investment in upgrades will garner $20,000 in annual increased rent then there limited incentive to make the investment in upgrades.
One method to assure lower turnover is to eliminate rental rate increases, right? This is a terrible business strategy, however, and will result in rental income deterioration in rapid fashion. Often, increasing rents will create some turnover, but along with this (sometimes) intentional turnover comes an opportunity to upgrade facilities and charge higher rents for these upgrades.
Consider the bigger the gap between current rents and Gross Potential Rent, the greater the incentive to upgrade interior space to capture this additional rent and close the gap between current rents and GPR.
What you measure is what improves
In my book, How To Read A Rent Roll, two full chapters are devoted to metrics that outline how to convert rent and revenue growth into a single measurable number per calculation. Having the capacity to identify rent growth allows you, the property manager or owner, to determine appropriate levels of investment estimate Rent On Equity (ROE) and Return On Investment (ROI).
- Measure quarterly rent growth for the last four quarters for each asset in your portfolio.
- Determine the primary source of rent growth for each asset.
- What is the investment necessary to accelerate rent growth? Does the investment make good business sense?
This article is an excerpt from the book How To Read A Rent Roll: A guide to understanding rental income by John Wilhoit, Jr.
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