Insight 11: Don’t Bank on a Flight to Quality
By Jay Parsons, Greg Willett and David Polewchak
Over the past few decades, the “flight to quality” was a go-to strategy for many apartment investors.
The theory is simple: When tough times hit, renters will flock to high-quality assets in high-quality locations. Investors typically define “high quality” as Class A assets in more dense, urban locations. The strategy generally worked in past downturns to varying degrees.
But in 2020-2021? Not so much. The world has changed – and not just due to COVID-19 peeling away some appeal for urban living. Developers over the last cycle flooded the market with very high-end, very expensive new apartments generally concentrated in urban submarkets.
Today’s Class A properties are materially more expensive – widening the gap between Class A and Class B. The new math makes it significantly challenging to lure Class B, and instead creates an environment where high-quality assets are cannibalizing one another for renters.
How can operators and investors adjust to the new realities of 2021 – and the new math that alters the long-time investment premise?
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The New Math
In the mid-2000s leading up to the Great Financial Crisis, a typical Class A apartment nationally was about $300 more expensive per month than a Class B unit. That fairly manageable gap allowed property managers to lure some Class B renters up to higher-end properties with rent cuts and concessions.
But that price gap surged over the following decade.
By the time COVID-19 hit in 1Q 2020, an average Class A apartment cost $500 more per month than a Class B unit. That gap is almost impossible to overcome with any reasonable rent cut or discount. But that hasn’t stopped property managers from trying. The gap shrunk to $400 by year-end 2020, but with little benefit to occupancy – suggesting few move-ups. Fundamentals remain much stronger in Class B versus Class A.
In concession terms, a $400 gap amounts to a four-month concession. We’re only hearing of discounts at such levels in limited cases – which may buy some short-term occupancy but will almost surely backfire and damage rent rolls longer term.
So, What Do We Do Now?
With the old-school playbook now off the table, what options are left? Here are strategies to consider.
- Get realistic. Sell the message internally that the concession-heavy strategy is going to hurt more than help in 2021. You can’t march forward until you can get everyone aligned to the realities of 2021.
- Get to bottom-line pricing. Concessions will buy you a short-term fix at an expensive long-term cost. Focus instead on bottom-line effective rents guided by your revenue management program. Trust the science and don’t try to play games with your prospective renters. Consider concessions on a very limited basis – such as in rent-controlled markets where renewal rent growth is limited and concessions are excluded in the base rent. We’ll address this topic in more depth in Insight #12.
- Get precise. In Class A and A+ units, rent cuts may remain necessary in many submarkets in 2021. But are cuts really needed across the board – or only in certain floorplans with significant exposure issues? Focus on the need.
- Get new and renewal leasing strategies aligned. One big mistake from 2020: Some operators slashed rents on new leases (often via concessions) while holding the line on renewal pricing. That just incentivized renters to go shop around, triggering a vacancy spike and more turn costs. Remember that demand is demand – whether new or renewal. Be holistic in your approach. Any resident can check your website to see what you’re charging today for similar units.
- Get focused on retention. This isn’t just about pricing but also about service. Focus on the basics of high-touch service, but also ensure your communities are easy to do business with. Empower your residents to interact with you on their terms, not yours, via a 24/7 service model that isn’t limited to leasing office hours. And push sticky programs like Community Rewards that engage residents and drive-up reputation scores.
Give your strategic planning the edge to seize opportunities, fine-tune your focus and outperform your competition in 2021. Download the guide now.