When the market softens and vacancies begin to rise, apartment operators traditionally turn to lease concessions. Whether they take the form of discounted rent or gifts such as a free iPad or a free television, the goal of concessions is the same: boost occupancy.
But while concessions do have the benefit of decreasing vacancy rates, they can cause their fair share of trouble down the road including increased out of pocket expenses or even devaluing a property. Instead of offering concessions, operators should consider boosting occupancy by permanently doing away with security deposits.
The Current Climate
Multifamily has been on a roll for the last decade. Rents soared while vacancies were sliced razor-thin.
But the market has softened recently as new development has increased. And where there is a lot of new construction, there are bound to be lease concessions. This past spring, RealPage noted that rental concessions are particularly prevalent in the 15 markets with the most new supply.
In September, Doug Ressler, director of business intelligence with research firm Yardi Matrix, told National Real Estate Investor that concessions are now present in all 133 apartment markets tracked by the company.
Concessions could increase in the months ahead. In the National Multifamily Housing Council's most recent quarterly survey of CEOs and other senior executives of apartment-related firms, the survey's Market Tightness Index was 41. A reading below 50 indicates that market conditions are getting looser.
The Problems with Concessions
When you're in the midst of a softening market and you see more and more units sitting unoccupied, concessions can seem like a great idea as they are a quick way to increase traffic and incentivize prospects to sign leases. But they are not without considerable drawbacks, particularly discounted rent.
For starters, concessions in the form of discounted rent or month(s) of free rent pack an unwelcome financial punch. Lower effective rents can decrease the value of a community and harm operating budgets. This devalued asset combined with a softening market can put a property and portfolio into an economic tailspin.
Additionally, offering a certain kind of discounted rent can decrease the likelihood of a renewal. Take the following example: the market rate rent for an apartment is $1,200 a month. As a concession, a resident is given a monthly discount of $100.
When it's time to renew, market conditions have improved significantly and the market rate for the unit is now $1,260, a 5 percent increase over the previous rate. But to the resident who has been paying "only" $1,100 a month, this seems like a nearly 15 percent increase. A renter facing this scenario is likely to look elsewhere for a home.
Anecdotally, apartment operators who offer incentives like free televisions or iPads have shared that residents who are drawn to these concessions are not often motivated to stay at a community for the long term. In other words, residents are sometimes there only or primarily for the gift, and operators could soon be facing the marketing and turnover costs associated with a unit that's vacant sooner than desired.
Doing Away with Security Deposits
Instead of focusing on concessions in a sluggish environment, operators should consider permanently eliminating security deposits as a way to attract quality residents in both soft and strong markets.
For applicants – especially in this age of stagnant incomes – it's often not possible to pull together the funds necessary to place a big security deposit payment. As a result, operators often lose prospects who would otherwise be perfectly good residents because they can't afford the security deposit.
Not requiring residents to place a security deposit can offer a community a significant competitive advantage without devaluing a property. Eliminating deposits also eliminates the tension and bad feelings that inevitably arise when a resident receives a smaller portion of their deposit returned to them at move-out than they were anticipating.
Not having to manage security deposits, issue refund checks, and handle refund disputes also saves associates and their property management firm considerable time and money.
Simply put, communities that do not require security deposits make move-ins more affordable for residents, make life easier for associates, and drastically reduce the need for concessions when the market turns soft.