The Market Rate and Rent Concessions

I was reading the Houston Apartment Association’s magazine, Abode, and it had an article that was written by the Texas Apartment Association about rent concessions. One thing that it mentioned was that rent concession had to be tied to a reasonable market rate for that apartment. This makes sense as you don’t want landlords discounting 90% off the supposed market rate, and if the resident is late one time, they suddenly owe 10 times the amount of their rent. I understand that aspect.

What I don’t understand is when they say that the market rate “reflects the rent for similar dwelling at comparable properties” and “what the specific unit would rent for at the time the lease contract was negotiated.” What I can’t seem to “get” is that if the community could rent a unit at a certain rate, they wouldn’t be using a concession – they would just rent the unit at that original market rate. By having a concession, by default that should mean that the market rate is unachievable.

The only exception I can imagine is a lease-up or low occupancy situation where you technically could rent at the market rate, but the concession is designed to quickly eliminate vacancy. But what I often see are concessions as a normal state of business, where the concessioned rate is truly the market rate, and the concession is really just a marketing scheme to indicate some sort of bargain to the apartment prospect. In other words, if the concession is required on an ongoing basis, then the market rate is a fairy tale…

So can anybody explain what I’m not getting in this equation?

Brent,

You are right to be a little confused - it's really all just marketing tactics.

In the situations you describe, the "market rate" is really the rate it was a year or two ago, at the peak of the boom or the rate they hope it will rise to again when the lease is up.

From the landlord's point of view (at least for rent-controlled properties here in Los Angeles) it's better business practice to offer a "concession" instead of lower rent.

The reason is that when the lease is up, the rent then "increases" to the agreed upon "market rate".

Otherwise you are stuck with a low base rent when the economy improves and rents go up again.

Does that make any sense?

Brian,
Thanks so much for the response, and I understand exactly what you are saying. It goes back to what I said about all of this being purely a marketing game. My concern, ultimately, is one of the later statements from TAA:

If your unit rent rate before offering the concession or discount is not the market rental rate, you may be exposing yourself and your company to claims of misrepresentation or fraud.

And based upon what you've said, then communities are violating this across the board, which means they have some element of exposure to charges of fraud, at least in Texas according to TAA. So either the risk is being overstated by TAA, or at some point there is going to be a legal response to this practice.

Market rate is the retail price of the apt. if you will. The concession or abatement is the discounted rate. A concession is a price that is generally taking out monthly over the lease term and an abatement is usually when the owner takes the hit all at once up front (like 1 month free) The purpose for the market rate is more for the lendors. Every property usually builds in a concession and an abatment line item to their budgets. If you made the concession rent the market rent then you have brought the value of your property down and a bank will not loan on the value of the property being as it may. Its kind of like in the retail industry, there is a retail price, sale price and a wholesale price. Hope that helps!

Thanks for the response, Cheryl! To clarify for everybody, I do understand concessions overall - Wanted "clear my name" on that front! But I was just wanting to make sure I wasn't missing something, because all evidence was pointing towards a violation of what TAA/HAA was suggesting! And it looks like the main difference is that they are suggesting that market rate is a short term measurement, whereas on the lending side, it should be a long-term measurement. It makes sense not to have loans constantly defaulting because of a short-term dip in the market.

But regardless of the lending issues, TAA is suggesting that rates should essentially be "marked to market" on somewhat real-time basis. I'm going to reach out to HAA and TAA and see if they will weigh in on this...

When purchasing or building a community a gross rent standard needs to be established with your lender. These would be considered "market rents". Concessions or even a mark to market model like a revenue management system will create a variance. In budgets and accounting, companies need to record this variance somehow and do so with a concession, discount, or variance line. You could even consider it a marketing expense item as adjusting price or offering concessions is obviously a marketing strategy and consistency is critical for fair housing purposes. The reality is that concessions or price adjustments don't just stop one day and go away. Even if rates get back to zero concessions or the "market rate", any good company will begin increasing rents to grow the market rate and increase the gross rent standard. Without growing the gross rent standard the value of a community can be subject to relying on cap rates as the main factor in determining any increases in value for the asset. I guess the bottom line is that concessions (or whatever you want to call them) need to be accounted for with reporting to lenders and even with determining other things like property taxes. Clear as mud? Does that help?

Hey Mark,
Thanks for jumping into the discussion. I think, ultimately, the traditional market rate has several long term uses, so it can't be changed every day to reflect actual ongoing market conditions. Here is the my problem:

1) TAA says that the market rate is "what the specific unit would rent for at the time the lease contract was negotiated." (italics added for emphasis)
2) Therefore, the market rate used for budgets or lending purposes cannot be used, as they reflect long-term market rates instead of achievable rental rates on that particular day.
3) One must assume that barring a special circumstance (i.e., lease-up), a community would rent the unit at the highest possible rate, which would then be the "market rate" for that particular day.
4) Therefore, in this situation, the market rate equals the concessioned rate for that day.

Ultimately, the problem is that the market rate is tied to the particular day rather than an average of some sort over a longer term.

Anyway, didn't mean to belabor the point, but considering the way I read it, the majority of apartment communities could be at risk for fraud charges, I thought it was worth discussing...

I think the TAA has it wrong. For example, if i go to buy a car and the MSRP is $25,000, but they are offering a low interest rate deal, $2000 cash back, and i negotiate with them to lower the price another $2000, then does the MSRP have to change in order for them to not be frauds? You could say this for any item on sale. I believe they make a good point about market rates being reasonable, but my MSRP or "market rate" has to be set at something. I don't see where fraud comes into play, I guess, given what you've shared. People sign leases and concession addendums that typically outline any market rates, discounts, and stipulations regarding rent. If it's in the paperwork it really doesn't seem fraudulant to me. I suppose there could be a case for companies not outlining all details in their lease paperwork or addendums, but having to define "market rate" as today's rate doesn't seem necessary to me. If that is the case then I'll just change our terminology to MSRP or Management Suggested Rental Price.

I think the only time fraud comes into play is when you end up charging all of the concession back to the resident because they are late, which I see a lot in my market, but may not be common outside of Texas (?). I don't think it is an issue upon the initial lease, as like you said, it is simply on "sale".

And a big part of me agrees with you about the contract - if it is in the contract and they sign it, then they should know what it says and means, and if they don't, they shouldn't sign it. However, people just don't operate like that a lot of the time, and I can definitely see potential abuse where the landlord defines market rate as some unrealistic amount double their actual rent, and then if they are late once, they suddenly owe a significant amount of money.

So the lesson is, let the buyer beware and read the fine print.

Brent,

Your analysis is spot on. The notion of "market rent" as something other than the net effective rent is archaic, but this industry adapts to new ideas VERY slowly.

I've talked with numerous large and small companies on acquisition under-writing and here's an interest fact they all agree on:

Scenario 1: I'm underwriting a rent roll for an acquistion of a community that is currently offering 1-month free on a $1,200 rent for 12 months. My pro forma argues that we'll bleed off the concession over the next year since the selling company is under-motivated and we'll re-energize the management of the community.

Scenario 2: I'm underwriting a rent roll for an acquistion of a community that is currently offering $1,100 rent for 12 months with no concession. My pro forma argues that we'll increase rents to $1,200 over the next year since the selling company is under-motivated and we'll re-energize the management of the community.

Scenario #1 is an easy sell and I'll have no trouble underwriting it. Scenario #2 will never get underwritten. BUT IT'S THE EXACT SAME CASH FLOW.

This isn't about logic. It's about old school rules of thumb that, imo, are no longer relevant--especially in an era embracing revenue management. But old rules of thumb die slowly--and revman is an operating paradigm while A&D is a deal paradigm.

I have not been a fan of using financial incentives to get a prospect to commit; it simply affects the P&L and the NOI fo the property negatively. Even if I am given the authority to offer them (as they were authorized by minds better than mine); I would only mention them when the prospective resident a) asks specifically about them (What's in it for me?), or b) when the prospective resident appears to be on the fence. Very rarely have I needed to rely on a financial incentive to get the commitment.

Alternatively, I would ask for the authority to offer a non-monetary incentive to commit.

Here are some examples off the top of my head, many of these things are easy to do if they are looking to move into a unit that is not currently ready:

1) Offer the resident the chance to select paint colors, either from a pallet of colors, or ask them to provide the paint before move in, just tell the painters to use the paint provided instead of the standard color.

2) Offer the resident the choice of flooring; some people may not WANT carpet.

3) Offer upgraded kitchen/bathroom hardware; or a ceiling fan if there isn't one.

4) If your bathrooms have showers that require curtains, offer to install a sliding door instead.

Anybody can offer $ off either move in costs, or monthly rent (everybody in the area probably is); but, speaking as a prospective resident, I am more likely to remember being offered an opportunity to make my home MINE!

If a financial incentive is offered, make sure that they understand that; if the lease is terminated early, the resident is responsible for funds equal to the total discounts offered; in addition to any lease termination fee.

@ Johnny; I could not agree more. Service and comfort are most important and make the most impact. The discount is something that most resident understand to not be a true discount (correct or incorrect).

If you take the example of hotels and their "rack rates" you will see that most often the actual rate paid is much lower and budgets were established don that lower figure.
I would take a wild stab at this and say that most (or all)discount/ concessions are planned in some ways in the budget and prospective residents tend to know that.
Ongoing concessions "trains" the consumer and ultimately the consumer will now ask for more than what they perceive as a planned discount.
I have always believed that people will pay fir value for fair services as well as top dollars for top services and accommodations. If that was not true the Ritz-Carlton would be out of business.
Provide great services and negotiate rents only if you cannot stand out from your competition should be the drive of each and every company.
I believe that a dollar worth of pay for a dollar worth of service is fair and should be expected. Here is the best part... Service is not expensive it is about commitment and pigheaded discipline and determination...

Both Johnny & Frederic are on the money. It is about "services offered" - that will wow the prospective resident first. Then Frederic's line "negotitate rents only if you cannot stand out from your competition" says it all. And those services offered and Johnny's idea of customization of your home will cut down on turnover down the road. That has to be good!

Let's not get caught up in how we WANT prospects to react. It's true that it's preferable to give non-monetary concessions. But the simply fact is that a) almost all of us do NOT run communities equivalent to the Ritz-Carlton, so we can't use that as that model mentioned earlier by someone in this thread (the luxury pricing model of no discounting only works with truly luxury product--and I mean luxury as in Four Seasons and Ritz-Carltong, not how every apartment operator advertises "luxury apartments) and b) most Americans like to believe they're getting a "deal." So with pricing software like LRO, we can calculate the appropriate effective rent and then mark up the asking rent so that the concession is really a discount strategy, not a reduction of rent.

We may not want this to be true, but every mass market retailer does some version of this (e.g. Target, car dealers, cruise lines, mass market hotels like Marriott, etc.). The only exception is Walmart with their "every day low price" mantra. And everyday low pricing isn't a smart pricing strategy for capacity constrained products like ours. It's fine for them where they can just order more widgets if they sell well; if we price so that we rent all our units, then we leave rent growth opportunities on the table.

As an industry, we need to get sophisticated in our pricing approach and analysis and get away from "Rules of thumb" and alleged "best practices." The travel industry is so far ahead of us on pricing. They've got cost challenges that inhibit profitability (particularly the airlines), but they have very sophisticated and successful pricing strategies.

I think you sum it up extremely well there Donald. I recently read an ebook that Seth Godin shared on pricing. I believe it's an interesting read for anyone as it shares some compelling case studies.

Download it FREE here sethgodin.typepad.com/files/26237737-fix...exible-the-ebook.pdf

Donald,
Absolutely great points across the board. In a response to your first comment, it's sad that perception gets in the way of good business practices.

For your second comment, I agree that pricing based upon a concept of "luxury" is a challenging thing, and overall, we still have a long ways to go when it comes to pricing strategies. However, I do believe there are other unique differentiators that our industry hasn't come close to touching upon, which could take us significantly away from commodity pricing models. We might be ready for that step by 2030...

Mark - thanks for the link - I'll check it out!

Donald,
I certainly was not making product comparison but simply making the point that people will pay fair price for fair value. That discounting is loosing its marketing value when everyone is doing it. The discounted price is the expected price and consumer who shops for discounts will ask for more than that which will ultimately hurt the bottom line.
As far as large retailers the limitations you face is that your residents are not buying multiple products. Many (almost all) discounts in the big box retail world are designed to generate traffic and other purchases.
You said it best with the airlines... Their smart pricing is making it nearly impossible to turn a profit in that business that correlates to the risk that comes with the investment. All these companies are fighting to survive and most are dying. Not quite sure this has turned out like what they expected. In the travel industry the product is very different and when you book your trip has a great deal to do with the price you get.
Pricing is all about balance and keeping some level of consistency. In multifamily the buying time line is fairly constant and I would believe that pricing would also have to be fairly constant which is certainly not true in the travel business.
When it comes to discounts it should be seasonal and used with caution, a well priced product will always sell.

I think we make a mistake when we talk of how people respond to any marketing or pricing tactic in a broad sweep. I agree that there is a savvy market segment that just focuses on the net. But there's also a segment that responds positively to discounts.

On the airline analogy, i think you missed my point. I believe the airlines are POSITIVELY impacted by their pricing systems. In fact, they've taught the public to get used to dynamic, supply/demand-based pricing. They've done a remarkable job responding to the economic challenges by reducing supply and pricing to keep their planes full.

The issues with airline profitability have to do primarily with cost structures that are unsustainable. Add on top of that the volatility in fuel pricing and their two biggest costs (people and fuel) are just out of line with what the market will pay for (note that SW which has the lowest people and fuel costs has made oodles of money over the past two decades). That's an employee management and cost management issue--not a pricing issue.

You do make a very valid point. I guess it fair to say that the 2 businesses are vastly different but there are lessons we can learn from everywhere. SW does run a very solid business. I was looking at the overall state of the industry where it appears that while some have been able to build a business model around the pricing model of today many (most) have had a very hard time with it because of the cost structures.
Discount do have a certain value for a segment of the residents and will help get some tenants I just have seen many cases where the price disparities create frustration amongst consumer in the airline business. It does come down to pricing strategy without a doubt and has to be closely managed on an ongoing basis.
The different factors that can impact that strategy are specific to each market place. Absorption rates and renewal strategies are 2 factors that I would certainly believe. An example would for a community near a college where fighting for occupancy in the summer month may not be smart as higher rent maybe reachable in the 3 weeks prior to school going back in session.
Thank you for great points you bring in this conversation!

I can see this discussion thread is generally looking at this issue from the owner's point of view. My husband and I are on the verge of signing as tenants a lease agreement with a sizeable apartment community owned by an even larger company. We put a $250 hold down to be able to sleep on the choice without having to lose the "daily market price" or whatever they were calling the rent that day. I requested to see the actual unit rather than just the model before I would pay move-in fees and sign a lease, but was told the unit "wasn't ready yet." So this seemed unfair to me that I would have needed to "Hold" an apartment with monies whose refundability would expire prior to my even seeing the unit with my own eyes. I think this is a tactic that should not be allowed. Just because a tricky marketing strategy is widely used does not therefore mean it has integrity. So, I still really wanted the place (assuming the unit would meet at least a reasonable standard close to the model, which I was assured verbally that it would be) and chose to move forward with giving the company money orders for move- in, which included prorated rent for the rest of the current month plus security of $500 deposit. Still, I asked to see the unit which was supposed to be ready "soon." At this point we set a move-in date, and after a few more days passed, we became concerned that we would have to double-pay rent at the new place plus our current residence if we didn't give notice asap. So we did put in 30-day where we live now. Finally, we get a walk-thru four days before our move-in date. I still had refused to sign the lease agreement until seeing the unit. Sure enough, the agent said, "it's not quite ready" and every sub-par item I pointed out was responded to with, "yeah, they'll do that before you move in." We're talking about deep cracks along all the window frames in the walls as well as old rusty fixtures and corners that were filthy yet painted over. The wood cabinets from the model were nothing like the kitchen cab doors in this unit - ours were painted over with gloppy paint and half of them so warped they did not close properly. I was disappointed, but since I now had no place to live in less than 30 days, we went ahead and asked to sign the lease. Now, in our e-mail arrives a 63 pages of legalese - sentences that run on for over twenty lines, redundancies, seeming contradictions, as well as actual charges they intend to bill us against, seeming to far exceed our security deposit. Plus the "rent" we were quoted is apparently including a concession of about $280 per month, on-going. If at any time we break our lease (18 month) we will be held responsible for back-pay of all concession, plus a "fee" of over $1600 in addition to the remainder of rent for month lease is broken plus and additional month. In this economic climate, we are nervous - what if one of us gets laid off, or encounters a health problem or other situation which would force us to have to break lease and say, live in my parent's guest room? It's happened to some of our siblings already, and not unusual. Plus, it looks as though we'll be responsible for this back-pay even in the event the Lessor breaks the lease, based on things that are "by the sole opinion and discretion of the Lessor."

So, to encounter threads like this, time and again, where it's said so patently that we tenants always have the option to not sign a lease, so therefore it's okay and legal for these agreements to be 63 confusing pages long...Well, it's pretty insulting. Tenants should not require the employment of a real estate lawyer to interpret and sign a lease agreement. Lessors know this and pad these agreements with so much junk. To say we have recourse of "just not signing" is totally untrue. I now have 20 days to either sign this agreement while I do not agree (or even understand) half of it, or what? Find a different place, get the run-around for weeks, lose hold fees right and left only to face yet another 60 page form I don't agree with signing. We have to sign something so we have a place to live in three weeks...

Owners have enticed tenants up to a barrel, gotten us bent over it, and now here we sit.

B&Ms, I sorry to hear about your frustrations. I can absolutely understand where you're coming from. From the management side we are looking to protect both parties, but sometimes the language and clauses we draw up in our leases appear to lean in our direction. I appreciate you outlining your situation in such detail. In thinking about what you've outlined and your apparent dissatisfaction with the new apartment I would personally recommend a few things for you to consider. These are not legal recommendations or in association with my company, but are my personal viewpoints from experience.

1. If you really don't like the place I would look for some kind of way to get your $250 back. I'd even recommend you try to speak with someone higher up than the manager at the property. Many times they are just following the guidelines they are given, but circumstances such as yours could be an exception. Worth a try.

2. See if you can pull your 30 day notice and go MTM at your current property. If they haven't already released your apartment this could be a possibility. This will allow you time to look for a different place.

3. When looking for your next place ask for a copy of the lease during the search. Any reputable company should be happy to share this with you.

From what you outlined, I don't hear anything about the terms of this potential lease as out of the ordinary. Unfortunately leases can be long, and I think it's very smart of you to be as thorough as you have been with the terms and process. At the end of the day this is about you. If I'm the management company I want you to be happy. If you're not then it's my goal to make it right. This company should feel the same way, but if your gut is telling you differently then the tough lesson here may be the loss of $250 unfortunately. I wish you the best of luck in your situation.

Please don't move into an apartment that you already don't like. You will be miserable and looking to move from Day 1. I would not want any Resident to go into the community on their Move-In day already unhappy. I would rather lose $250 than pay thousands of dollars over the course of - did you say 18 months? to a management company I feel mistreated me.

I would put my requests in writing to the manager and forward a copy to the corporate headquarters and see if you can achieve some remedy.

In your search for a new home, NEVER look at the model until after you have seen the unit you will be renting, if at all possible. I always want Prospective Residents to see what THEIR home looks like bare walls and all. Then have the Leasing Professional or Manager take you to the "tricked out" model unit. That way, especially if the two units are the same floor plan, for example, you might get some nice decorating tips after seeing the Model.

I won't go into all the business side of this topic right now; however, our company gives Prospects all the charges up front in writing as far in advance of the scheduled move in date as possible, so there is time to answer questions. Sometimes, move in dates are incorrect or the agreed upon rent is miscalculated, etc. Because a lot of management companies utilitze revenue management software that sets the rent rate every day based on market conditions, it is important that Prospective Residents know this. I feel badly that you are experiencing such stress at a time when you should be feeling happy anticipation.

I agree - see if you can go month to month at your current apartment. If you can't, then call around for a short term rental, or put your things in storage and live in your family's Guest Room. There are apartment communities where the management and maintenance teams love to provide great service to their Residents and they want you to be happy. Those communities are worth the wait.

Just for the record, I am not an attorney, but I have worked with many new Residents who were or who had their attorneys on the phone or brought them while we signed the lease paperwork. I have literally had to answer every single point (to the best of my ability) and I can't tell you the number of times people have asked me to change something in the Lease. I am not an attorney and I did not create this Lease; therefore I cannot alter the terms of your Lease, but I will enforce them so it is imperative we all understand what it says. Those Lease Signings take up to four hours to complete. One took place as I was driving from one property to another and the Manager called me to talk to the girl's attorney on the phone (good thing it was a 4 hour drive.) If you, as a Prospect, have questions about Lease terms, ask them! Don't ever put yourself in the position of feeling "stuck." Should the leasing person or manager not know how to answer your questions, they should be able to get someone on the phone at least, who can.

I know you are upset now, but not every management company operates like the one with which you are dealing. There are many reputable companies. Call some local Realtors in your area and the local Apartment Association and see if they can help you locate an apartment community that will meet your needs. I work with a lot of Realors to find housing for their clients.

Good Luck!