Driving occupancy in a time when demand dips is challenging. Recent data indicates the pace of leasing is picking up after bottoming out in the early stages of the coronavirus pandemic. But we’re still in the midst of a recession caused by COVID-19, and many residents and prospects will continue to experience profound economic hardship.
In an effort to fill apartment homes, many operators will offer prospective residents a helping hand in the form of a month of free rent, reduced or slashed security deposits and fees or lower monthly rates. But in their quest to maintain or bolster their physical occupancy rates, apartment communities should be careful not to sacrifice their economic occupancy rates (i.e., the percentage of potential gross income that a property achieves for the lease). Unfortunately, common lease concessions - especially reduced security deposits - can eat away at a property’s economic occupancy.
Don’t Reduce Deposits and Call It a Day
When an apartment community collects rent from a lease, the economic occupancy rate equals the money actually received. So, if the property was able to receive all of its potential funds, the economic occupancy on that lease would be 100 percent.
In a sluggish demand market or in submarkets with competition from new construction, communities might turn to financial concessions to draw in new residents. How often have you seen offers of six weeks of free rent or a 14-month lease with two months free, or deposit specials of $99 or even $0? I would venture to say quite often.
These types of concessions have a certain appeal and logic. They ease a prospect’s financial burden and help communities convert more leases. But in the case of security deposit-related concessions, they can have an adverse impact on a community’s economic occupancy. While $0 deposit offers may entice prospects looking for a more affordable move-in experience and can boost physical occupancy rates in the short-term, they can leave operators with dangerously little protection in the event the resident doesn’t pay their rent or leaves significant damage. Without a way to cover those losses, a property’s net operating income - and economic occupancy - is shot.
A Practical Solution: Eliminate Deposits
One way to maintain economic occupancy in any market condition and for any asset class is to eliminate security deposits entirely and replace them with lease insurance.
“It was a no-brainer to replace security deposits portfolio-wide with lease insurance. It has proven to be the only solution to replace the long-standing deposit problem in the apartment industry,” remarks John Detore, Director of Asset Management for White Oak.
Large, upfront security deposits, which typically are equal to one month’s rent, have long represented a significant financial obstacle for many prospective residents. A community that eliminates and replaces them with lease insurance can offer a serious and meaningful enticement to prospects while still maintaining economic occupancy and protecting against bad debt.
Even before the pandemic and the accompanying economic recession hit, concerns about the affordability of moving into an apartment had grown to the extent that states and local governments were taking action.
Jurisdictions across the U.S. are requiring operators to offer more options than just the traditional upfront security deposit. Pennsylvania is considering a bill specifically mandating that renters be given the option of lease insurance instead of a deposit.
In a down or competitive market, operators face a tremendous challenge. They have to provide the kinds of economic incentives that will draw in new residents while also protecting their economic occupancy. By getting rid of security deposits and replacing them with lease insurance, they can accomplish both goals.