When concessions on a 240 unit eat the entire underwritten rent bump

Question

Take a 240 unit in a submarket with two lease-ups within a mile. Asking rents on the rent roll average 1,650. Effective is closer to 1,512 once concessions come out, with the T-3 showing them running about 8 percent of gross potential. Bad debt is 3.2 percent, and the seller's broker is presenting a loss-to-lease of 6 percent against those 1,650 asks. The problem is the stack. Mark to market off 1,650 while concessions are running 8 percent and the buyer is paying for rent that nobody in the property is actually paying. Underwrite off 1,512 and assume concessions burn off in year two and the whole return depends on a supply forecast nobody controls. A seller's T-12 that nets concessions into rental income on one line hides the monthly shape of it entirely without the ledger. How are people handling the burn-off assumption right now, and what do you require in the diligence file before you will believe it? Year one at 1,512 flat with 3 percent bad debt gets to a 5.1 going-in yield, which the debt does not cover.

Rena Expert · Accepted Answer

Underwrite effective rent and treat burn-off as an upside case that isn't required to service debt. That's the only version of this that survives a submarket where deliveries are still landing.

First, fix the accounting before the forecast. Get the monthly GPR-to-net-rental bridge by line: gross potential, loss to lease, vacancy, concessions, non-revenue units, bad debt, then other income. If the seller's system nets concessions into rental revenue, request the concession detail report and the new lease trade-out report by month. Two months free on a 12 month lease is 16.7 percent off, and it shows up differently depending on whether the site amortized it across the term or gave it as free months up front. Those two produce the same annual number and completely different in-place rents on the 60 percent of leases rolling in your first year.

Second, your loss to lease is being double counted. A 6 percent LTL against 1,650 asks assumes the asks are achievable. If new leases are signing at 1,512 net, the market rent is roughly 1,512 and the LTL is close to zero, possibly negative. You can't book both LTL capture and concession burn-off off the same base.

What I'd want in the file: 12 months of new lease and renewal trade-outs separately, current concessions at the two comps in writing from a shopper, and the delivery schedule for anything under construction within a mile with expected first-occupancy dates.

The risk you haven't priced is expense side. In a concession fight, marketing spend and turn costs rise, and turnover at 55 percent instead of 45 on 240 units is 24 extra turns at whatever your turn cost runs. Also check whether bad debt at 3.2 is a screening problem, because that follows you through the recovery and doesn't burn off with the supply.

omar_haddad · Answer

The turn cost piece is where these deals go sideways in my experience on the renovation side. If the last owner was giving two months free, they were probably also going light on turns to protect cash. Pull ten unit files and see what was actually spent per turn. If it's 600 a unit on a 240 unit property with 40 percent turnover, your year one is paying for their deferral, and that's before any classic-to-renovated scope.

megan_doyle15 · Answer

What's a trade-out report? Is that just the difference between the old rent and the new rent on the same unit?

diane_kowalski · Answer

@megan_doyle15 yes, and the reason sextant wants new lease and renewal split out is that they move in opposite directions in an oversupplied submarket. Renewals can be up 3 percent while new leases are down 6, and a blended number hides that. If the blend looks flat, the property is filling vacancy at a discount and holding existing residents at higher rents that they'll walk away from eventually.

wendy_park48 · Answer

Check whether the concession sits in the lease itself or in a separate addendum with a clawback. Plenty of leases make the free month repayable if the resident breaks early. The site never collects it, yet the accounting still carries it as recoverable, which inflates other income. Also ask whether any of that 8 percent is employee units or model units being run through concessions rather than shown as non revenue. On 240 units, four models and three employee units is 3 percent of the rent roll that will never pay.

kevin_lombard · Answer

If effective rent is 1,512 and the two lease-ups down the street are the reason, doesn't the whole thesis just come down to when those two properties finish leasing up? Once they're full, do concessions actually stop, or do they stay because everyone's residents got used to them?

paulgrant17 · Answer

The 3.2 percent bad debt would worry me more than the concessions. Concessions are a price decision you can reverse. Bad debt at that level usually means the criteria got loosened to hit occupancy during lease-up pressure, and you inherit the residents, not just the policy. Ask for the delinquency aging and how many of those are on payment plans.

karen_whitfield · Answer

@kevinlombard they mostly stop, but slowly, and the last owner to drop them is the one who needed occupancy most. Nobody can put a date on that for you. @dpatelre if 1,512 flat gets you to a 5.1 and the debt needs more, you already have your answer on price rather than on assumptions. I'd rather sit on a deal for two more quarters and watch the delivery schedule empty out than buy the burn-off. Though I hold things for fifteen years, so my patience is cheap and yours may not be.

When concessions on a 240 unit eat the entire underwritten rent bump

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