27Feb

Renewal Pricing: Why Insight Trumps Renewal Caps

Author: Rainmaker Team

Knowledge-sharingThis final installment of our blog “Multifamily Renewals 2.0”series discusses how analytics provide a better way to set renewal prices than arbitrary caps and why a revamped renewals process is good for residents.

Renewals account on average for more than 50 percent of a multifamily community’s revenue. Yet, while new lease pricing has seen an explosion in analytical capabilities over the last 15 years, renewals lag far behind. As we have argued in this series, companies answer the basic question of how much to charge relative to the current in-place rent and current market rates in a suboptimal and inconsistent manner.

There is a common trade-off in renewal pricing: on the one hand, large increases can drive revenue growth and leverage the residents’ expense to move while on the other hand, small increases avoid vacancy loss and also generate goodwill. So, it’s natural that many renewal pricing decisions involve the setting of a cap on rent increases.

Once again, in stark contrast to how new prices are set, these renewals decisions tend to be based more on operational intuition than on comprehensive analytics. As we demonstrated earlier – that tends to lead operators to be more timid than they should be, leaving revenue on the table. In softening markets, we have seen caps as low as 3 percent, and occasionally even at 0 percent. While there are often good reasons to implement a cap, it is rare that a cap based on intuition (and fear) ends up being optimal.

In a previous post, we presented data underlining the financial impact of small renewal rent increases. The graphs below illustrate the response to renewal rate increases, in particular how renewal rates vary in two different markets based on cohorts of increase. The graphs are based on four years of data that spanned strong and weak market conditions. As a result, the increases reflected market conditions (i.e., this data does not represent arbitrary increases in different cohorts; the increases are correct contextually to market conditions).

renewal_curve

What stands out from this analysis is how little renewal rates decline on increases in the 8-12 percent range. Then there is a clear inflection point such that increases above that range lead to markedly lower renewal rates.

In rising markets, caps on renewals are rarely the optimal strategy. Even if increases cause a decline in renewals, this is more than made up for in the long run with a better rent roll. In declining market conditions (particularly inverted markets), it may be appropriate to ensure that rates of renewals area maximized to help defend occupancy. In these cases, caps should generally be set at 10 percent increase or higher, and almost never below 8 percent. Remember that new rents aren’t going up in these scenarios, so anyone getting an increase that is capped must have been getting a very low rent for quite a while.

With the growth in market rents slowing down there aren’t going to be too many of these offers, so the effect should be minimal; however, setting a very low cap could have a material impact on the very leases that are most likely able to tolerate the increase.

Why Renewal Pricing 2.0 is Good News for Residents

As we have demonstrated in this blog series, there is financial upside in improving the renewal pricing process, both in the form of more profitable (or less unprofitable) decisions, and improved customer experience.

The renewal process is not an experience that naturally inspires delight in residents, and operators struggle to manage perception as they agree to renewal terms with residents. Furthermore, a lack of transparency in the process makes it hard to understand why renewal rents are what they are, leaving associates less confident than they need to be. The lack of transparency also makes it harder to apply “lessons learned” from prior renewal results.

Multifamily Renewals 2.0

All of this is solvable by a robust Renewal Pricing 2.0 platform. By building and implementing an optimized renewals strategy based on comprehensive data and analytics, of the type we described above, renewal pricing becomes more optimal and more consistent.

With less randomness in the process, and with greater insight into the formulation of the renewal strategy, onsite teams can truly understand those offers, and in turn, they have the confidence to meet with residents and explain them with detail and authority. They can tell their residents why their renewal offer is what it is, and have informed, confident and professional conversations with them. That can improve customer experience and potentially increase the likelihood of retention.

Forward-thinking operators are adopting renewal pricing technologies whose rigor and analytical power fits the renewal process in the same way that conventional revenue management fits the process for new lease pricing. Those operators will be positioned to optimize top-line revenue in whatever market-softening lies ahead – as well as make the most of the next market boom.

 

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