When I first got involved with the industry, few operators offered leases shorter than 12 months (except through corporate housing providers. And when they offered shorter-term leases, they were typically limited to only 6- or 9-month leases.
With the adoption of revenue management systems (RMS), it became possible to know mathematically what appropriate rents would be for various lease terms so that operators could be indifferent to prospects' choices. Sure, shorter-term leases increase vacancy loss and increase turn costs, but if the premium for those terms is high enough, then operators can be ok with that.
How revenue management changed lease terms
Operators began using these RMSs along with more sophisticated approaches to lease expiration management (LEM) to offer "best priced" rents for lease terms less than 12 months when they needed to. The objective was to use shorter lease terms to improve a property's expiration profile. However, prospects and residents didn't respond to the shorter lease terms as well as the operators offering them had hoped.
That led to a substantial increase in the practice of offering longer-term leases. Prospects were much more amenable to accepting 15-18 month terms that moved the expiration than they were to 6-9 month lease terms. And with these longer-term leases came a decrease in frictional vacancy. Publicly-traded REITs seemed to lead the way as their reported occupancies grew from mid-95s in the "aughts" to low-to-mid 96s in the teens.
Those two items form the case for long-term leases: 1) more nimbleness on shaping LEM profiles and 2) reduced turnover leading to decreased vacancy loss and turn costs. There is a potential cost to longer lease terms: reduced rent growth from a delay in getting higher rents upon renewal. That cost has been more than offset by the gains from better LEM as well as reduced vacancy and turn costs. Longer-term leases can be even more beneficial for larger (500+ units) communities, where lower turnover helps the leasing team to maintain occupancy and eases pressure on the service teams responsible for turning units.
What it means for this recovery
However, as we see the light at the end of the tunnel that has been the COVID-19 recession, it's worth asking whether the cost of foregoing rent increases for a number of months is worthwhile. Given our earlier commentary on this recession's K-shaped recovery, it shouldn't surprise anyone that the answer will depend on the market:
There's every reason to believe that history will repeat itself. Once we get to a point of vaccine ubiquity, we could see a large increase in demand for urban living and the consequential increase in rents. If these rent growths exceed 10%, the cost of deferring that growth may exceed the savings in high occupancy. However, this presumes a forecast of rapid rent growth. If you are forecasting stabilization and only moderate rent growth, then the case for longer lease terms holds.
As with all decisions about the future, there's no sure bet. But for at least the rest of 2021, it's worth asking the question!
Donald is CEO of Real Estate Business Analytics (REBA) and principal for D2 Demand Solutions, and industry consulting firm focused on business intelligence, pricing and revenue management, sales performance improvement and other topline processes