Solving Economic Vacancy by Rewarding Renter Behavior
Investors Need to Outperform the Market
by Rowland Hobbs
For every real estate investor, a common challenge is trying to predict the difference between gross potential rent and the actual rent received at the end of the year. At the beginning of the year, in a building with 100 units that average $1,000 in monthly rent, gross potential rent is $1,200,000. However, as the year comes to a close, the actual rent received is only $800,000. The $400,000 difference between gross potential rent and actual rent received is economic vacancy, and being able to both predict and solve for it helps investors improve NOI and property values.
Economic vacancy occurs when a resident does not:
Move into an apartment as quickly as expected and causes higher marketing costs, concessions, and discounts required to lease the unit as well as longer downtime
Pay their rent, causing delinquency, arrears, and bad debt
Renew their lease, causing higher make-ready costs and more downtime
So how can you take into account and accurately predict renters’ behaviors to avoid vacancy? Change them.
Outperforming the Market
A number of highly effective tools are available to help you price units and capture data on the real estate market. However, these tools are designed to help their users perform in-line with the market, not outperform it. To outperform the market, you need a tool that is targeted and will provide a way for you to capture data on your residents to meet their needs, and that optimizes overtime.
This begins with understanding four primary sources of economic vacancy: downtime—the period of time a unit sits vacant; delinquency and bad debt—when a renter does not pay their rent and this money is written off as a loss; make-ready and turn costs—the expense that is associated with leasing an apartment to a new renter; and marketing and concessions—that are either too high, resulting in an unnecessary loss in revenue, or are too low and not producing intended results.
Until real estate owners actively and accurately adopt and deploy tools focused on changing resident behavior through targeted rewards that are personalized to the resident experience, real estate will continue to struggle to reduce economic vacancy. Without reducing economic vacancy, net operating income and property values suffer.
Why Current Solutions Do Not Work
The current solution to addressing economic vacancy is to give new renters one month free rent, gift cards, or worse, lowering the rent. However, these incentives do not enable rental communities to outperform the market because they are not designed to change renter behavior. These offers are so common that they do not stand out in listings or in ads and often confuse renters when they are presented as “net effective rent.” Additionally, these concessions are often allocated imprecisely and not supported by data. The main reason one-month free rent (8.3% of annual rent) is offered is because the rental community across the street is doing so. And if an asset manager had the data to say a concession equivalent to 7% of annual rent would have the same outcome as 8.3% of annual rent (1-month free) there isn’t a practical way to implement it; “26 days free” does not exactly roll off the tongue. Real estate needs a simple, effective reward for renters that incentivizes specific actions. As with any sophisticated rewards and loyalty program, the reward should be supported and optimized by data, understood by the target market, and be efficient in terms of achieving a desired outcome at a reasonable cost.
The primary tool to avoid resident arrears are penalties and eviction. These penalties create a negative relationship between you and your renter. Also, the penalties only truly work once the problem exists; they do little to prevent the problem before it happens. Instead, increase your resident’s propensity to pay before they even move into your apartment. A reward that gives residents something back each month when they pay their rent lowers bad debt.
Such a reward lowers bad debt for two reasons. First, a regular reward gives residents a reason to pay each month because they get something back. Second, as with other loyalty programs, rewards tied to paying rent on-time will enable you to identify the most loyal and profitable residents. If a resident sees a listing with a reward tied to paying rent on-time, they are only going to be interested in the offer if they are confident they will be able to pay their rent. This dynamic then attracts more profitable residents to your rental community. These factors increase a resident’s propensity to pay and reduce economic vacancy from bad debt.
Give a Reason to Stay
When it’s time to send a resident a renewal offer—especially with rising rents—it’s challenging to make it enticing, causing high rates of turnover. The resident just spent 12 months living in an apartment, paying rent on time, and they don’t have anything to show for it. Even worse, residents are often “thanked” for their time in the apartment with a rent increase, one that can be quite high if the resident had one month free in their initial lease. All of this creates a negative experience for the resident causing less renewals and increasing make-ready and turnover costs. Give residents a reason to stay and increase renewals, in turn reducing make- ready and turn costs and lowering vacancy.
Economic vacancy is a complex and costly problem in real estate. There has yet to be a comprehensive solution to address it in a way that enables you to outperform the market while improving NOI and property values. Rewards that incentivize your renters and residents to take a specific action to reduce economic vacancy and are optimized with data and technology, achieve better outcomes and reduce economic vacancy.
