Multifamily Guys/Gals: Concessions vs Lowering Rents
Which do you find to be more accretive to NOI? Giving concessions or simply lowering rents?
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Specifically in times of high vacancy rates and oversupply
From a "theoretical" POV i'm not really sure and I don't want to sit around and think about it, but from a practical standpoint I think, concessions are better from a valuation standpoint because concessions only affect the proforma for 1 year. After the year with the concession, the rent roll will appear to be market or even above market, which will give the property a higher valuation for refinance and potentially sale if the buyer doesn't do their due diligence and look at concessions. Also, people tend not to like to move. If your rent for a 1BR for example is $3k/month, but you get 1 month free, are you really going to move the next year for a place that is maybe $2750? A lot of people just say fuck it and continue renting and now each time rent increases, it is based on the $3k figure without concessions. Just my opinion, I could be wrong.
Agree that most people "don't like to move" unless it's a SUPER concessionary environment then maybe. Also the psychology behind getting 8 weeks FREE is probably a huge factor. I tend to agree concessions are better but just wanted to get some arguments for both sides. We toured a property today that said instead of offering concessions, they opted to lower the rent which seemed weird to me.
Reducing rents is more honest - rents needed to be at “X” level to obtain a lease.
The use of concessions in lieu of lowering rents is designed to allow a 3rd parties (buyers, lenders, etc.) the opportunity to fool themselves into thinking that it “doesn’t count” that the actual lease payment stream is 8% (1 month free) lower than the printed number.
There is a certain, non-trivial % of tenants who will move special to special each year - so it’s not a “one time” thing.
We value our time and hassle to want to avoid moving. They view it as they’re getting paid (via rent concession) to move since their time and hassle has a low value and therefore a positive economic trade. They are used to being more transient.
In my experience, I'd prefer concessions. Most people don't bother to move if the rent increase is marginal after year 1. Also reduces turnover cost.
Rent reduction signals a new comp to the market too which may affect other apartments in the area.
Concessions are better for the proforma as generally they're only for 1 year.
That said, if you're in a high vacancy market and struggling to lease up, concessions probably won't get you there and you're better off dropping headline rents (think - as a typical renter, what's the first thing you look at? Headline rents or net of concessions?)
Think it depends on how it's advertised. If I see 8 weeks free upfront, I'd probably lean towards that. You're right though, I don't think most people are thinking like me and are calculating effective rent over a 12 month period lol. Lowering rents would for sure help on a quick filter by price on apartments.com.
I would say MOST people actually think more simply than that "Apartment X is $2400, apartment Y is $2200, I will go for apartment Y because it is good enough for my needs".
Assuming the average renter is calculating their effective rent is giving humans way too much credit.
Where concessions tend to actually start coming into play is when both X and Y are $2400.
Lowering rents can have massive repercussions with lenders. At some point, all pro formas are a little bit of bullshit, and if I'm taking on non-recourse debt, I want to pump that rent roll up as a high as possible. Easier to explain to a lender's credit committee that concessions will burn off rather than rents will increase by 8% or whatever.
Always remember that most people in finance aren't stupid, but they are extremely risk averse and unwilling to gamble with their own money. Always always always pitch lenders/investors in such a way that if things go sideways, they have plausible deniability as to why it isn't their fault, because that's what they're looking for too.
Lowering rent causes lenders to ask a lot of questions and investors to panic. Also DSCR calcs punish you for lower rents as opposed to concessions (at least the one calc I ran into).
Lowering rents gets you made fun of for being a pussy at happy hours with your industry friends, but neither are good. I have never cut rents across the board in my entire real estate career.
I have, however, offered a free month on a 13 month lease during leaseup, offered $500 gift cards if you sign and move in during the same month, told the leasing staff that if they got me 30 leases that month I would pay them all a $5,000 bonus, picked 2-3 "special units" to offer $100 off per month with a look and lease special, put anyone who signed a lease into a drawing for a Porsche Experience at the official track, etc. Minus the first, those aren't concessions - they are well spent marketing dollars.
Totally different...
Another valid approach -- which circles back to the original question of what you're solving for. If Average In-Place Rent for a 2-Bedroom is $1,000 but you set the Market Rent at $3,000 then your loss-to-lease is silly and either 1) your market rent is off or 2) $3,000 reflects the market rent for a fully renovated apartment and the current condition of your 2-Bedroom is comparatively rat-infested lol.
It's also worth mentioning that I'm speaking from experience of managing a 75-unit high-end luxury rental in PB where folks are locking in 3 to 5-year deals at $20,000 + 5%. Plainly, we're not in the concession business considering the demographic. But say construction was completed 45 days past the written lease date then we "may" offer a concession but it wouldn't be upfront.
To preserve the "quality" of your property's comparable rent performance, lower rents.
The use of concessions effectively says to the market that you needed to offer a concession to garner the leased rent.
From an investor POV (and from my own experience), I assign a discount to concession-heavy properties.
You also assign a discount to properties with lower rents, because the NOI is lower...
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