The deal world. Gotta love it. Smart people doing deals worth tens of millions. Even hundreds of millions of dollars. Surely with that much money at stake, processes are wired tightly and there’s really no room for pricing shenanigans, right? Of course if you believe that, you probably thought sub-prime mortgages were a great investment back in 2007 as well.

Here’s something that I’ve wondered about for the 15 or so years I’ve been doing pricing and revenue management in multi-family housing. Two different deal scenarios:

“Hey boss, I’ve got this great deal we should take to under-writing. We’re buying from  XYZ Apartments, and they’re cutting back on this market. They’ve way under-managed the asset, and their team knew a sale was likely so they’ve been in pretty poor morale. They’re doing average rents of about $1200 a month with one month free. I know we can burn off that concession over the next year and really kick ass.”

“Hey boss, I’ve got this great deal we should take to under-writing. We’re buying from  XYZ Apartments, and they’re cutting back on this market. They’ve way under-managed the asset, and their team knew a sale was likely so they’ve been in pretty poor morale. They’re doing average rents of about $1100 a month net. I know we can grow those rents to at least $1200 [ed. Note: that’s an 8.33% increase] in the next year and really kick ass.”

Every acquisition guy (or gal) I’ve talked to and presented these two scenarios tells me the same thing. The first scenario gets under-written without a second thought while second scenario doesn’t have a snowball’s chance in hell of getting underwritten. BUT THEY’RE IDENTICAL CASH FLOWS.

Why is that? I believe that the legacy of discounts being presented as “concessions” which are a bad thing to get rid of lends credence to the idea that surely you can burn off a 1-month concession in an under-managed asset. Meanwhile, rent growth of even 2-3% can be challenging to get, so an 8.33% growth in “market rent” (quotation marks intentional to mean “alleged market rent”) just seems too tall a hill to climb.

Yet from a pricing psychology perspective, people like to perceive they’re getting something for “free.” So if anything, removing a “freebie” might hurt demand MORE than just raising rents. Yet our deal guys and under-writers are more willing to do that than increase base rents. With tools like LRO and Yieldstar, operators have gotten use to looking at net cash flows in making their pricing decisions. What will it take for deal guys to catch up? Now’s your chance to chime in—am I missing something? Anyone out there have deal guys who would disagree with this? Join the discussion—there’s literally tens of millions of dollars (or more) at stake!