Whether the multifamily property industry is in a soft or strong market cycle, occupancy levels remain top priority for property managers and when the market softens and demand dips, driving occupancy becomes a challenge.
In an effort to fill apartments, many property managers will offer prospective tenants a helping hand in the form of either a month of rent free, a reduced cash deposit and/or lower monthly rental rates.
However, in their quest to maintain or bolster occupancy rates, property managers should be careful not to sacrifice their economic occupancy rates i.e.,the percentage of potential gross income that the property achieves for the lease. Unfortunately, common lease concessions, especially reduced cash deposits, can eat away at a property’s economic occupancy, says LeaseSurance, a new B2B InsurTech product underwritten by Bryte.
The problem with concessions
In a sluggish demand market or in submarkets with increased competition, property managers often turn to financial concessions to attract new tenants. How often have you seen offers of ‘one-month rent free’, ‘reduced rental rates’, or ‘50% deposit’, even ‘no deposit’ specials?
When a property manager collects rent, the economic occupancy rate equals the money received. If the property was able to receive all of its potential funds, the economic occupancy on that lease would be 100%. Financial concession reduces economic occupancy:
Discounted rental offers
Offering a discounted rental lowers the economic occupancy and it can decrease the likelihood of tenant retention.
As an example, the market rental rate for an apartment is R5,000 per month. As a concession, a tenant is given a monthly discount of R500, money that the landlord forfeits.
When it is time to renew the lease, market conditions may have improved and the market rate for the unit is now R5,250, a 5% increase over the previous rental rate. However, to the tenant, who has been paying R4,500 per month, this new rate appears to be a 15% increase. A tenant facing this scenario is likely to look elsewhere.
While discounted offers may be a quick way to incentivize a prospective tenant to commit to a lease, the impact on economic occupancy is severe. Using a second example, an apartment of R5,000 per month over a typical 12-month lease period contributes R60,000 to the landlord’s net income for the year. Giving away one month’s rent for free (R5,000) means that the gross income is R55,000, reducing the economic occupancy to 91.7% (8.3% was given away with this promotional offer).
Multiply this over large property portfolios, over an extended period, and the discount expense line will eat away at the landlord’s bottom line.
These incentivised offers also impact a property manager’s ability to retain tenants for extended periods.
Cash deposit related concessions also have an adverse impact on a property’s economic occupancy. While ‘no deposit’ offers may entice prospective tenants looking for a more affordable move-in experience and can boost physical occupancy rates in the short-term, they can leave property managers with dangerously little protection in the event that the tenant doesn’t pay their rent or leaves significant damage behind. Without a way to cover those losses, a property’s net operating income – and economic occupancy – is shot.
A practical solution: replace deposits with lease insurance
One way to maintain economic occupancy in any market condition, and for any asset class, is to eliminate cash deposits entirely by replacing them with lease insurance.
Large, upfront deposits, which typically equate to one month’s rent, have long represented a significant financial obstacle for many prospective tenants. A property that eliminates and replaces cash deposits with lease insurance can entice prospective tenants while still maintaining economic occupancy with protection against bad debt.
Eliminating a cash deposit can offer a property a significant competitive advantage without devaluing it, while removing tension that inevitably arises when a tenant receives a smaller portion of their deposit returned to them on move-out.
Not having to manage cash deposits, administer deposit refunds, and handle refund disputes also saves property managers considerable time and money.
Simply put, properties that do not require cash deposits make move-ins more affordable for tenants, drastically reducing the need for concessions while still protecting against bad debt – more protection than cash deposits!