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How to Approach Pricing in a Softening Market

How to Approach Pricing in a Softening Market

The U.S. apartment market is on a nine-year run of rising returns, the longest stretch of positive rent growth we have experienced historically. However, moderating performance has become a key theme following the national market peak in 2015. While many market segments continue to put up solid results, the moderation seen in national performance is being driven by softening in certain segments.

While a handful of components characterize softening market segments, typically the one you will observe is a shift from a rent growth focus to an occupancy focus. Essentially, operators begin prioritizing high occupancy in an effort to maintain their current rent roll. This typically comes at the sacrifice of rent growth on both sides of the pricing coin – new leases and renewals. The effort surrounds the need to fill up the apartments and keep current residents in place to shelter the assets from the impending downshift in rents. Makes sense, right? As an operator, you work hard to get those rents in place and you want to protect that. And as an operator, your job is to protect the asset, which includes stabilization of occupancy and the rent roll, regardless of the market conditions.

One of the things I have learned throughout my career in the multifamily industry is that there is always money to be made regardless of market condition. This is achieved by applying asset strategies that complement your goals as an operator with the asset hold period. With that, you have to approach pricing strategically and thoughtfully, and you can do this by reviewing a handful of important metrics that influence overall pricing success.

Let’s tackle this first by identifying a scenario that requires a different approach to pricing. Excess supply in economics refers to a situation where the quantity of an entity supplied is more than the quantity demanded. Now, if we consider a market to have more current supply then current demand, it is considered oversupplied. Typically, oversupply is a product of a transitional market, where the market is taking on more units from new construction or value-add renovations that transition unit classifications. When a shift in the number of units available occurs, the resulting absorption of those units is tracked so that operators can understand the impact. Absorption rates are tracked as it related to the changing supply level and the utilization of that supply over a period of time.

If we look at the Class A segment of a downtown corridor in a major market like Seattle, you would see that the supply levels have been increasing and demand is lagging. As an operator of Class A stabilized assets in one of these markets experiencing a period of oversupply, how do you approach pricing? First and foremost, the projected absorption rate and the time horizon are important elements to understand. Essentially, you will want to understand the period in which you will experience the excess supply and the application of the supply, often referred to as supply shock or an inflection point, throughout the given time horizon. Inflection points here represent additional supply entering the market.

How you compensate for these changes in supply and the resulting demand is how your pricing strategy is formed. For example, if the excess supply will be realized over the next 12 months with three inflection points, your strategy may be different than if the excess supply is realized over the next 24 months with six inflection points. Timing is critical. An effective pricing strategy must include your asset-specific strategy, application of the market dynamics and the realization of your opportunity. In the situation of excess supply, a major concern is occupancy lowering. So how do you combat that? With an effective pricing strategy.

Excess supply is only one scenario characterized in a softening market, but what about markets that experience economic factors that contribute to a softening market? As I described earlier, rent growth is another element defining a softening market, and many of our markets have seen historic rent growth over the past nine years. Revenue management at its core is the balance of two elements – rental rates and utilization. Essentially, optimal revenue is achieved when rental rates are achieved and applied. If rental rates are at historic highs, the economics of the market dictate the resulting utilization. The important thing to remember here is, the market will eventually come down, but the path down is tempered. These up and down changes in our markets are felt over time and rarely change quickly. What this provides is an opportunity to strategize and equip your asset.

Regardless of the specific scenario of softening you are or may experience, let’s look at some way to position pricing for success. On the renewal side of pricing, it is important to look at resident retention, current rent roll opportunity and lease term offerings. You will want to lock in a higher resident retention percentage while looking for opportunities in your rent roll to put a higher rent in place from where it may stand now, and for a potentially longer period of time. By locking in a high resident retention, you will inevitably reduce exposure levels. Reviewing opportunities within your existing rent roll to put a high rent in place allows you to advance your revenue using your existing resident base, where all rent increases, if achieved, add revenue without additional turn costs. Look for rents on your current rent roll that are significantly below market rents versus the rents closer or at market rents. Strategize offers to capitalize on these. Often the expiration or renewal side are overlooked when developing a strategy, but this is one area that should absolutely be incorporated because it constitutes over 50% of your annual revenue.

On the new-lease side, look at demand management, including lead source effectiveness and sales effectiveness, expiration management and lease term offerings, along with revenue management settings that contribute to a faster response to softening demand. If you can capitalize on generating good leads from good sources and capturing those leads, then you can weather the excess supply while continuing to advance revenue. If you think about the leasing process from a top-of-funnel approach, it is all about the generation of those leads from your advertising sources. Ensure that your advertising sources are producing enough leads, effective leads and exposure- and unit-type specific leads ensure needed demand levels. Your teams being able to capitalize on those leads effectively and efficiently will ensure you capture leads being generated by your advertising sources.

Once leads are captured, appropriate lease expiration management enables lease expirations to expire where demand is anticipated and as demand changes. With a softening market, demand changes will be realized, so having a revenue management system that identifies expiration periods and demand changes will ensure alignment is achieved. With regards to lease term offerings, as I referenced earlier, identifying the excess supply period and time horizon will allow you to strategize what lease terms will allow expirations to be minimalized during the excess supply time horizon, therefore reducing the number of expirations and potential exposure you will experience during this excess supply time. As for your revenue management settings, allowing the settings to complement a faster response to growing exposure and softening demand will ensure that your pricing response is fast and congruent with your asset strategy and the changing market.

Overall, the best way to approach pricing for a softening market is to set an asset strategy that complements your goals for your asset while aligning that strategy and goal with the behavior of the market.

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