Even though the prevailing sentiment in the multifamily industry has been to never offer renewal rates less than a current resident's rent, current market conditions should prompt you to re-think this approach because retaining that resident at a lower renewal rate will earn you more revenue than signing a new resident.
Here's why.
1) Turnover costs are more expensive than ever.
Well, everything is more expensive, really.
It's why expert rental housing economist Jay Parsons says expense control will be a significant theme for apartment operators in 2024.
He recently shared in this LinkedIn post the year-over-year increase in expenses per unit (2021-2022).
Other than property insurance, the cost of turnover rose the sharpest.
If controlling expenses is something you're valuing right now, then it's clear that the most direct way to do that is to prioritize resident retention.
When fewer people leave your apartment community, you avoid paying for the labor, parts, and marketing necessary to prepare a unit for the next resident.
There are varying estimates, but one thing is sure: Turnover is expensive. According to Express RPM, the average turnover cost of a single unit is 1-3x monthly rent. Statista puts the average cost nationwide at about $4,000/unit.
Some of these estimates don't even include the most obvious cost of turnover, vacancy loss.
The bottom line is that there's a higher incentive for winning more renewals in today's market. Keep reading to see the proof.
2) Rent prices are falling.
With rent prices steadily dropping, you must consider that most of your current residents are paying rents above the market rate from when they began their lease.
This significantly impacts their decision to renew their lease.
Before their lease ends, they'll see what new (and future) residents are charged. And they'll want to pay the same amount as new residents (after all, if they intend to stay, they feel there should be some reward for loyalty).
If you're unwilling to offer prices equal to the current market rate—especially in a down market—the implications for your community can be severe.
- The current resident will move out, and you'll be on the hook financially to pay the costs of turning over the unit.
- They'll likely leave a negative review online that future prospects will see.
- That excess turnover will force you to invest more in marketing or implement rent specials to maintain occupancy goals.
Parsons also cites an uncertain demand outlook, and the upcoming spike in new units coming online will also warrant the need to retain residents.
So, what's the harm in breaking tradition regarding renewals and offering a renewal rate that is less than what a current resident is paying?
It's worth it—especially given today's market conditions. We'll break down the math in the next section.
3) Renewing below a resident's current rate can be a financial win when rental rates fall.
Let's do a little math, shall we?
Here are our hypothetical numbers.
Current Rent: $2,000/month
Market Rate: $1,900/month
Renewal Rate: $1,900/month
Average Vacancy Duration: 21 Days
Turnover Cost: $2,000
We want to calculate the difference between winning a renewal and signing a new lease.
To do this, we're going to use the following equation.
Lease Profit = Total Rent Revenue - Vacancy Loss - Turnover Costs
This equation captures the total rent revenue you'll gain from a 12-month lease minus any vacancy loss and minus any turnover costs.
Because we want to next calculate the vacancy loss of 21 days, we need to first calculate the daily revenue of a lease. To do that, use this formula:
Daily Rate = Rate/30.5 days
We're using 30.5 days to calculate the daily rate because some months have 30 days, others have 31 (and February has 28?!). Ultimately, we want to get as close as possible to the revenue we get each day from a lease.
Next, we calculate vacancy loss with this equation:
Vacancy Loss = (Average Vacancy Duration x (Market Rate/30.5))
Putting it all together, we can calculate our lease profit from signing a new lease using this formula:
Lease Profit = (365 x (Rate/30.5)) - (Avg. Vacancy Duration x (Rate/30.5)) - Turnover Costs
Now plugging in our scenario data, here is the lease profit when signing a new lease at market rate (each line simplifies one element):
Lease Profit = (365 x $1900/30.5) - (21 x ($1900/30.5)) - $2000
Lease Profit = (365 x $62.30) - (21 x $62.30) - $2000
Lease Profit = $22,739.50 - $1,308.30 - $2000
Lease Profit from signing a new lease = $19,431.20
Now, let's do the same calculation for renewing a current resident at market rate, or $100/month less than what they're currently paying. Note we enter zero's for both turnover costs and vacancy loss.
Lease Profit = (365 x $1900/30.5) - (0 x ($1900/30.5)) - $0
Lease Profit = (365 x $62.30) - (0 x $62.30) - $0
Lease Profit = $22,739.50 - $0 - $0
Lease Profit from winning a renewal below current residents’ rent = $22,739.50
In this scenario, we renewed the current resident at $100 per month less than their current rate to match the market rate. Believe us—your current resident will be thrilled! And this renewal will earn you over $3,300 more in revenue over the same period compared to losing this resident and signing a new lease at the market rate.
Conclusion
The math verifies the revenue benefits of breaking with normal renewal tendencies and offering a lower rate to a current resident, specifically in a softening market. You avoid all the turnover costs (labor, parts, marketing) and vacancy loss. Plus, you're controlling expenses all by simply choosing to lower your renewal rate.
The point we're trying to drive home here is that when rental rates fall, you should strongly consider renewing leases at market rates!