At first glance, the challenge for operators in lease-up can look especially daunting. They have to deal with a vast amount of supply becoming available within a compressed timeframe. They have to take a new development's occupancy from zero to stabilization over the course of a year while still achieving pro forma rents.
In this post, we'll take an in-depth look at the Lease-Up pricing philosophy – identified by Rainmaker's analysis of how operators use its LRO revenue management system. And we'll hear from industry experts Donald Davidoff and Bryan Pierce of Gables Residential about some of the nuances of this philosophy in action.
The Mechanics of the Lease-Up in LRO
Operators of communities coming online have pro forma rents and occupancy rates they are aiming to achieve by stabilization. In these instances, LRO is not given a lot of room to move prices up or down. Operators in this situation will want to give the system the opportunity to get more rent than was expected but at the same time the Lease-Up operator will put a very tight floor in order to not let the rents go down automatically beyond a certain point without human intervention.
Certainly, there are times when, if market conditions just won't let an operator lease at pro forma rent, the system will recommend to have to go below it. But the operator will want to do that with the developer being in the conversation and agreeing to it.
The Lease-Up operator also will set very high exposure thresholds to compensate for the simultaneous availability of so many new apartments and will configure LRO to anticipate a high leasing velocity.
Unless they’re clearly ahead of their occupancy budget, Lease-Up operators will keep their prices suppressed. To build occupancy, they will often turn on a concession and then let that concession burn off at renewal time. Once they do achieve those occupancy numbers, it’s common to see them become a little more comfortable and get aggressive with rent. Think about it: if an operator goes from 50 percent exposure to 10 percent, it's logical for them to think, "OK, we can push for a yield now. We have attained what we need to attain from an occupancy perspective. Let’s flip over to start getting a yield on this asset."
The switch to being aggressive with rent is particularly likely if the owner is planning on selling the new property soon after stabilization. Developers who build assets purely to sell them often will get a property up to roughly 93 percent occupancy at (hopefully) proforma rents. Then they’ll start pushing for yield up to the 95 percent level.
On the other hand, if the community is a build-to-hold, the owner will typically push occupancy up into the 95 percent range and then consider, "How do we want to operate this asset in this market?" Most of the time, the answer is a Balanced Pricer approach.
Matching Strategy to Objectives
Of course, within the Lease-Up philosophy, there are various wrinkles and subtleties in play when it comes to occupancy and pricing strategies. According to Davidoff, an expert in multifamily revenue management and an industry consultant, exact strategies – when to push occupancy, when to push rates – can vary based on the terms the development company has with their equity partners as well as loan covenants.
"What kind of time, rent and occupancy profile are they looking for?" Davidoff said. "That perspective will determine how they configure LRO to deliver the exact profile that they want."
Generally speaking, though, you never want to compete with yourself on renewals so there's a strong motivation to get stabilized within a year, Davidoff said. "That way, you don't have units being delivered while you deal with non-renewals."
Additionally, a developer that is looking to sell a community shortly after stabilization isn't the only owner motivated to push rents after occupancy goals are achieved, notes Pierce, director of revenue management at Gables Residential. If the developer is planning on holding the property while also developing new communities in the same submarket, they will want to grow rents or at least keep them elevated, he says.
"The first expectation is to get your cash flows up. The best way to do that is to get occupied," Pierce says. "From there, the priorities could change. If there’s a developer planning on developing more units in that area, they don’t want to see rents go backward because that impacts their ability to do that newer development. In that case, you’re going to see stated rents being held and – if need be – a lot of specials."
Finally, the Lease-Up philosophy isn't solely limited to new developments, Davidoff noted. It can be applied to communities completing major rehabilitation. "It’s the same sort of thing," he said. "Rehabs have lots of supply coming available all at once, and also have a pro forma leasing pace and rent goals because that's what the developer or redeveloper has spent an awful lot of money to achieve."
The multifamily industry is far from a "one-size-fits-all" sector when it comes to pricing and occupancy strategies. Some operators boldly embrace the risk that comes with aggressively pushing rent growth, while others ferociously guard against the slightest bit of vacancy loss.
Operators are dynamic and can move through different pricing and occupancy strategies at the same community over the course of time, depending on market conditions and ownership goals. Rainmaker recently identified five different pricing behaviors currently at work in the multifamily industry: Balanced Pricer, Occupancy Defender, Rent Driver, Vacancy Allergic and Lease-Up.
Regardless of which pricing strategy you currently pursue, having the right revenue management solution in place will help you make your objectives a reality.