Welcome back for another installment of the Apartment Budget series. Today we are going to talk about Loss to Lease. Interesting side note, I did a piece on this a number of years ago and to this day it remains the number one read article on this blog.
Before we get started, I wanted to post a note of clarity as it relates to my last entry – Apartment Budgets: Rental Income. Where I refer to Rental Income in that post – I am really talking about Gross Potential Rent as being the top line. You may also hear it referred to as GPR. In any event, I wanted to head off any confusion.
LTL
Now unless you have a brand new community in lease up, you will have in place leases that are very likely below the GPR. The primary reason being rent increases. Any time you increase rents you create a margin between the in place leases and the new increased GPR. This can occur in reverse and the impact to the LTL can go in reverse. That is to suggest that you can decrease the GPR and the margin or LTL becomes positive. Not a scenario you see to often as rents generally rise over time in lieu of decline over time.
Loss to Lease – New Move In
To put it simply; if you lease an apartment below the GPR, the discount is captured in a Loss to Lease – New Move In line item. To put some math to it; if your apartment’s GPR is $500 and you lease it for $450, the $50 reduction in rent is capture in the Loss to Lease – New Move In line item as a -$50 charge. And, it will exist for the life of the lease.
Loss to Lease – Renewals
When leases come up for renewal and they are under the GPR number – the margin is by default in the current Loss to Lease line item. When the lease renews, if it is still under the GPR that new number gets captured in the Loss to Lease – Renewal line item. Putting some math to it. Suppose your apartment’s GPR is $500 and the current in place lease is $450 – you renew it at $475. The $25 margin is captured in Loss to Lease – Renewals.
Total Effective Rent
Once you have accounted for your losses related to in place, new and renewed leases under the current Gross Rent Potential – you come up with a Total Effective Rent. That is where we will pick up next week.
We have purposefully left out the analysis piece this week because I think it will fuel some crazy cool discussion. Hope to see you in the comment section below.
Your – lovin’ budgets – multifamily maniac,
M
0 Responses
Love this post Mike as it’s major numbers geekery. Seriously though, isn’t this concept getting harder to calculate due to the proliferation of Revenue Management systems? The GPR right NOW is different than what it is for a 9 month lease or 15 month lease or next week’s GPR. How do you measure this effectively given these new systems?
Hey – thanks.
You ask a great question. I left EQR right around the time that Rev Mgnt was taking off and I seem to recall LTL and concessions being absolved completely leaving market (GPR) to be what it was. It ebbed and flowed every minute of the day depending on the eight or nine levers that governed the system. That said, I don’t have a ton of experience with it but would agree that at some point, it all goes away and the top line is what it is relative to what I mentioned above.
I think Rental Income becomes the truer metric. And, looking at that number on a Y/Y basis in lieu of a budget year comparison is where the real money is.
Thank you for taking the time – would love to see you back here in the future.
Have a compelling week.
M
We still calculate a loss to lease with Rev Mngmnt. We have a baseline GRS (Gross Rent Standard) vs. GPR. This is calculated as an average rent on a 12 month lease to create the standard and we review it annually to set the standard for our budget. If we achieve lower than the standard by reducing rent on a longer term lease, etc. it hits the variance line. Same goes for short term premiums or rent premiums in general. They just hit the standard variance line. We still have a “Premium Rent” line and “Concessions” line in our budgets in case we handle particular leases without using Rev Mngmnt for the premiums or discounts. Generally those are corporate leases or sometimes “Hot Units”.
Just one perspective on accounting for Rev Mngmnt. Hope that helps.
Mark
Thank you for chiming in on this one. I think we are headed the way of Rev Mgnt and no doubt this will be discussion point. We might have to hit you up for some advice as we venture down that road.
Have a great weekend. M
This maybe a stupid question, can you decrease the market rent of a unit to lessen loss to lease?
No stupid questions in my book. The short answer is yes. Common practice would suggest that you do not lower the rent to lessen that margin.
I do agree that you can absolutely reduce the market rent of a unit to lessen loss to lease, however if your Market Rents are way over market and you are giving away a lot of dollars in the loss to lease line I would highly recommend that you do an entire market adjustment to bring your Market more in line with what is actually happening in the market today.
In my opinion, it is sort of silly to have a gross overstatement of market rent and then an extremely large loss to lease number to offset it. It just adds noise when you are trying to analyze the data compared to market. It also allows you to keep your financials transparent and easy to read. This is the one area of financials that owners, investors, etc seem to struggle the most with and I explain over and over. Not because the concept is so hard to understand but when it is all put together everyone wants to know “what actually is in that number”. If you do not have good tools in place to keep this data organized and analyzed it is not easy to tell if the property is giving away renewals without getting a rent bump, if your market rent is grossly overstated, if you are giving away the world to new move in’s just to get them in there. It has been my expereince that property manager’s sometimes try to hide information in these lines to make it less obvious what they are or are not giving away.
When a lender reviews the financials they take into account the net of those two lines so as far as I can tell there is no benefit to having a grossly overstated Market Rent.
I’m new to this – and I’m trying to understand an income statement someone passed me. It seems they calculated the Actual Rents they collected – and then subtracted a LTL, getting them to Total Rental Income.
That can’t be right. Wouldn’t you take a ‘Hypothetical’ Gross Potential Rent (based on market), subtract the difference between market and the actual rent (the LTL) – and that would basically get you to your current actual rent.
Am I thinking about this correctly?
You are correct, in the scenario you listed above the income statement would be representing incorrect data, and the way you described it in your second paragragh is correct.
However, I would caution you that before you go back to whoever handed you the income statement you should verify with them just what exactly is in the “Actual Rent” line listed on the income statement and what is in the “LTL” line. I am an accountant in the Multi-Family Industry and have seen where the labeling on the income statement is incorrect (which immedialtey makes you assume the data is too) but after asking specific questions and gathering more data the overall information is correct, the wording was not.
Nathan
Thanks for taking the time to chime in – really appreciate it.
I think it could be a case of semantics as Carin implies. Different companies could/will use Actual Rent with equal definition to Gross Potential Rent. It would be good to ask for clarification via definition.
Mike, I’m enjoying your blog and particularly your attitude about the multifamily business. I recently joined a smallish family owned apartment investment company in Georgia, and I’m attempting to help them optimize their revenues. I suspect we are leaving money on the table as our occupancies are significantly above our peers. Your posts on Gross Potential Rent and Economic Loss have been helpful, but are there any general rules or suggestions for finding the ideal market rent?