Rent Concessions: What Multifamily Investors Need to Know
Rent concessions are making a comeback in some of the nation’s top apartment markets as new multifamily developments enter their lease-up phase. In slower markets, concessions are part of everyday life for property managers.
This data-driven article explores the types of rent concessions, the pros and cons of the discounts, the relationship between concessions and other market fundamentals, and when you’ll have to offer concessions to remain competitive.
What is a Rent Concession?
So what exactly is a concession? Simply put, a concession is any “reduction in price, rent or other benefit provided to a tenant or buyer as an inducement to buy or lease1.”
While there are many ways to get creative with rent concessions, two types are most common in the apartment industry.
Method A: ‘First month free’ type deals, where the concession is awarded out all at once.
Method B: A rent discount spread evenly over a period of time (typically the initial lease period).
Both concession methods can result in the exact same discount. Say, for example, you are a landlord letting an apartment unit at $1,200 a month over a year-long lease. Giving either a concession of $100 off each month’s rent (Renter A), or a free month at the start of the lease (Renter B), would result in the exact same amount of paid rent over the year-long lease: $13,200.
($1,200 lease rent) – ($100 concession) = $1,100 effective rent
($1,100 effective rent) x (12 months) = $13,200
($1,200 lease rent) x (11 months) = $13,200
While both scenarios have the same amount of rent paid, they have vastly different implications on the renter’s behavior and internal dialogue when it comes time to review.
Concessions and the Renter Psyche
It’s been a year at your property and Renter A and Renter B need to renew their leases or move on.
Renter A is reviewing your renewal letter that offers a year-long lease at $1,248/month — a 4% increase over their ‘market rate’ of $1,200, which falls in line with the local apartment market’s performance. But Renter A sees a $148 increase on the $1,100 check they have been writing each month — that’s a 13.5% increase in their mind. They might be tempted to give your property management staff a hard time — or decide to move out and look for a new concession elsewhere.
Now Renter B is looking at their renewal offer. Their $1,248/month offer looks very reasonable, considering they are used to paying $1,200 a month. Such a nominal increase is unlikely to lead them through the hassle of moving out into another apartment community so long as your property management staff has been taking good care for them.
Unless, of course, you have a professional rent hopper living in your building. These tenants can execute a ‘midnight move-out’, forfeiting their deposit — if there was one — and move into a new building in order to secure a new ‘first month free’ type deal.
To prevent this, some apartment managers will reward tenured renters with a slightly lower rent increase — or even a unit upgrade — if they have been a quality tenant that pays on time and doesn’t cause problems with staff or other residents.
Implications on Buying or Refinancing
When underwriting a property for a loan, lenders are interested in how much income an asset is producing and how much income an asset can optimally produce. Concessions add an additional layer to the equation.When underwriting the Net Cash Flow at an asset, concessions are typically subtracted from the Gross Rental Income in order to determine the Net Rental Income — which also factors in things like vacancy and unpaid rent that’s deemed ‘uncollectible’.
Concessions can be grouped into three different categories: Lease-Up Concessions, Marketing Concessions and ‘Red Flag’ Concessions.
Lease-Up Concessions: Discounts offered in newly constructed apartment product during the lease-up phase as mechanism to help reach stabilized occupancy (roughly 90%) quickly. These one-tine concessions are generally not of concern to lenders so long as there is strong lease-up velocity and that asking rents are well supported by the market.
Marketing Concessions: You might also find concessions at an older Class B or Class C investment opportunities. These are often more of a marketing play in that rents at the property may be slightly above market rates. The ‘concession’ brings rates more in line with the market. These types of concessions are usually of no concern — again, as long as the property is well occupied and rents are supported by the market.
‘Red Flag’ Concessions: Lenders might start expressing some concern when you are looking at buying or refinancing a property with rents that are in line with market competition, but for whatever reason, has on-going concessions to keep the property occupied. Generally this is a red flag that there are bigger issues going on.
Whatever your particular stance on concessions at your property, take care to clearly note all concession activity on your rent roll. It will make life easier for potential buyers and lenders.
Market Case Study — Concessions in the City
Enough talk, let’s examine some numbers. We’ll look at the impact that market fundamentals have on concessions in Manhattan because it is a large, competitive market with a robust development pipeline. While it is not a market known for widespread use of concessions, a consistent data series sheds light on some interesting behaviors.
(Note: In this data series, provided by Douglas Elliman and Miller Samuel Inc., a ‘concession’ includes broker fee waivers — another type of effective rent discount that occurs when the property owner pays the rental broker’s fee. This fee can hit 15% of yearly rent in Manhattan and certain trendier parts of Brooklyn. A methodology on the data in the charts below can be found here.)
The share of newly signed Manhattan leases with concessions is represented by the blue line below.
Note that these concessions fluctuate depending on the season. During the winter months — historically unpopular months to for move ins/outs — we see that the share of leases with concessions rise. During the late spring and summer months — the typical leasing season — we see the rate of concessions drop off.
Let’s take a step back and examine the larger multifamily cycle (the linear trend line). We see an overall increase of the use of concessions in Manhattan as the multifamily development pipeline begins to deliver a consistent stream of new units after taking a pause during the recessionary years.
You can get a sense of the correlation between concessions and construction. This chart examines the apparent relationship between the apartment listing inventory and share of new leases with concessions.
The two series veer away from each other in recent months on the right hand side of the graph. The drop in concessions can be explained by the summer leasing season. If the listing inventory continues to increase throughout the fall and winter — which it should given that an expected 17,000 new NYC apartments will greet perspective tenants for the first time in 2017 — we can expect to see a significant spike in the share of leases with concessions as rental activity slows down during the colder month and there is a plethora of new units to choose from.
But the market fundamental with the seemingly closest correlation to the rate of concessions in Manhattan appears to be the vacancy rate.
As vacancy rates increase, so does the rate of concessions — at what appears to be a two- to three-month lag in Manhattan’s case.
A Quick Look at Some Other Markets
While there is plenty of data available on market fundamentals in New York, there are many markets where concessions are much more popular.
ALN Multifamily Data, which tracks over 100,000 properties across the nation, was kind enough to provide us some information on the prevalence of concessions in the 20 largest markets they track. Here’s what that looks like:
The properties in these markets offer concessions that on average equate to a 5.25% discount off of ‘market rent’. In general, the markets at the top of this list are either having population/job growth issues (like Tucson) or an oversupply of apartment construction (like Houston). Or perhaps they just like to use concessions as a marketing tool, as appears to be the case with Las Vegas, a city with the second highest rate of concessions (35%), but the second lowest amount of rent conceded (4%). It isn’t a surprise that strong, primary markets like Miami and Los Angeles fall at the bottom of the list.
We hope you enjoyed the journey examining rent concessions. Here are some tips to keep in mind.
- Concessions are an effective tool to help stabilize a new property during it’s initial lease up.
- For established properties, concessions tend to be a marketing tool to convince renters they are getting a deal, when in fact their rent ends up being market value.
- If your chief market competition is offering concessions, you are likely going to have to join the game.
- Consider giving a concession off the first month’s rent instead of spreading it over the course of a lease. That way renters are not in for a reality check when it’s time to renew.
- To prevent good tenants from leaving to chase concessions, consider offering a lower rent increase, or the ability to pick an upgrade for their unit (i.e. new fridge, coat of paint, fixtures, etc.).
- If there is a significant amount of new construction in your market, your are likely going to need to offer deals to match the concessions promoted by these newer assets in order to retain strong occupancy.
- Clearly note all concession activity on your rent roll.
If you liked examining the concession data and market fundamentals in Manhattan, then you should check out our 2Q 2016 Small Balance Multifamily Investment Trends reports. Produced in conjunction with Chandan Economics, this quarterly data book examines trends in cap rates, DSCRs, debt per dollar of NOI, LTVs and more.
 Baron’s Dictionary of Real Estate Terms, Seventh Edition.