30Jan

Renewals Pricing: More Upside than You Realize

Author: Michael Mele

This is the fourth installment of our blog series on the sate of multifamily renewal pricing. We recently conducted an analysis that indicates how getting even slightly more aggressive with rate increases at renewal can have major impacts on community revenue. Below are our findings.

pexels-photo-265036Any property manager can get an idea of what their market is doing with respect to new lease pricing using market intelligence data, checking listing sites or calling local competitors. The challenge is that similar comparison pricing data on renewals pricing is not widely available.

However, the data does exist in property management and revenue management systems. We recently performed an analysis using lease data from thousands of multifamily properties shows the considerable potential upside associated with rent increases.

The Impact of Small Increments

To characterize the revenue opportunity offered by renewal pricing, we conducted a study using historical lease data from thousands of multifamily properties. The study revealed that raising the rate renewal increase, even by a minor amount, can have big impacts on revenue. If operators can make informed decisions about the likely impact of different pricing strategies, significant revenue-raising opportunities exist, the study suggests.

Take, for example, a property in the Atlanta market with 300 units and an average rent of $1,250. The community has a lease renewal rate between 55 percent and 60 percent, and it typically raises the rent on these leases by 4 percent when compared to the original lease. Out of context, the manager at this location may see 4 percent as a modest jump that keeps the cost of maintaining the unit steady while being low enough not to upset the resident. However, comparing the increase to the market casts a different light on the property’s decision.

For the purpose of this analysis we have considered the distribution of average renewal rent increases across the Atlanta market. The graph below compares the 4 percent rent increase to the average of all properties in Atlanta that renew at a similar 55-60 percent rate.

renewals_graph Average Renewal Price Increases for Atlanta with 55-60% Renewal Rates

 

The graph ranks properties in this section of the market according to their renewal increase rates and the percentiles along the horizontal axis give insight into the distribution of rate increases. The red line is set at 4 percent, the increase rate of our sample property. Looking at the horizontal axis, we can see this is in line with the 25th percentile of the market, meaning one-quarter of the properties in Atlanta that renew 55 to 60 percent of their leases increase their rents on renewals by 4 percent or less.

In other words, raising renewed rents by 4 percent puts our property in the lowest – or least aggressive – quarter of its market.

Although our original assessment of the 4 percent increase looked reasonable, it appears that the sample property is leaving money on the table since the majority of communities in the market have set their rates at a higher level. Their residents are obviously willing to pay the premium as they are renewing at exactly the same rate as the sample property.

The graph shows the median (50th percentile) of similar properties increase their rent for a renewed lease by about 5.5 percent. At the 75th percentile mark, we see properties increasing rent by 7 percent, meaning that approximately one-quarter of the properties in this section of the market increase their rents on renewals by at least 7 percent of the original lease price.

The fact that a full quarter of communities in the market raise their renewal rents by 7 percent and more shows what kind of opportunity was missed by our sample property and its 4 percent rate of increase. Specifically, that missed opportunity is worth about $70,000, the potential revenue gain that could be experienced by moving from the 25th percentile to the 75th percentile of rate of increase (apply a 6 percent cap rate to that incremental revenue, and the portfolio value creation is a stunning $1.17 million). Setting its average renewed lease rent at $1,337 instead of $1,300 could bring a 1.5 percent lift in revenue from renewals alone.

Why Small Increments are Getting Bigger

Finding the right renewal rate will prove to be even more important in the coming months and years as many large markets around the country see pricing dynamics shift. As we mentioned in our introduction to this series, supply has been the constraint in the pricing equation during the boom seen across the industry in the last few years, but some markets are already seeing demand become the constraint as new properties enter the fray, trying to capitalize on the bullish apartment industry.

In a demand-constrained setting, exposure is the enemy. When strong new lease rent growth is no longer assured, the best source for a revenue boost is renewals. Operators must strike a careful balance: protecting occupancy while resisting the temptation to over-estimate price sensitivity and underprice renewals. As our example has shown, underpricing of renewals is readily punished with lost revenue.

Renewal pricing has never been an exact science, but the financial rewards illustrated above are available to operators who can implement more effective pricing. Given this untapped financial upside and the urgency of changing markets, it is reasonable at this point to wonder why the industry has yet to capitalize on this opportunity.

Next week we will explore how to improve the renewals process.

Multifamily Renewals 2.0

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