By using lease expiration management to develop rent rates that encourage optimal lease terms, some companies are taking revenue management one step further.
Managing the pace of lease renewals has always been an important part of maximizing revenue for Carmel Partners Inc.
Because the company operates many strongly seasonal communities, it has used manual lease expiration management with its communities to move renewals outside of the slow months, says Erik Rogers, Vice President of Business Intelligence and Technology for the San Francisco-based real estate investor and operator.
Since 2008, however, Carmel Partners has used a revenue management system to employ automated lease expiration management, or LEM, a technique that guides leases to expire at a time that maximizes revenue.
“The system uses [rent] rates to motivate residents to take lease terms that renew in a high demand season,” Rogers says. “For example, the months from December through February are the slowest demand months at our Denver communities. The LEM functionality of the system automatically and continuously optimizes rates for length of stay so an optimum number of leases renew May through July, which are peak months.”
Residents can still get a lease that renews in winter, Rogers explains, but it will be priced higher in most circumstances. Likewise, the system uses price to motivate an optimum number of residents to renew in the summer when demand is at a peak.
Matching Expirations With Demand
Lease expiration management is a manual process at most multifamily housing companies. Community managers concentrate on keeping units filled to generate revenue and pay secondary attention to expiration timing. This approach often causes expirations to occur when demand—either from new residents or renewals—is low, and it may result in units remaining vacant longer than desired.
When a large number of units are vacant, managers routinely offer promotional incentives, which further erode rates and rental revenues.
At the heart of the problem is the standard method of using manual matrix-based renewal timing, rather than revenue, to manage lease expiration dates.
For example, operators usually set leases to expire during months with the fewest number of expirations. This method overlooks the option of using price to motivate residents to renew at an optimum expiration date.
LEM approaches the challenge of enewals and expirations in a systematic way. First, it helps eliminate dilution—getting less rent for a renewal than what an existing resident is willing to pay.
The traditional 3 percent increase in rent may not capture the existing resident’s maximum willingness to pay.
Second, LEM technology reduces vacancies and turn-costs by minimizing the number of move-outs. In times of high unemployment and low home prices, existing residents often pay significantly higher rents than what is offered to new residents. Lease expiration management processes help eliminate the guesswork by mathematically determining whether to increase the rents of existing residents and, if so, by how much to still maintain their loyalty.
Price Motivation
LEM solutions use advanced algorithms that may reward or penalize residents for specific lease terms. For example, two- and three-bedroom apartment units usually lease better during the summer when children are out of school.
One-bedroom apartment units tend to lease throughout the year.
These differentials among unit types are lost when operators maintain the traditional community lease expiration matrix. LEM considers the historic renewal behavior of existing residents and possible costs of vacancy loss resulting from departing residents, as well as price-sensitivity of new residents or renewals.
“To do effective price-based LEM, the concept of lease-term premiums must fade away,” says Rogers, whose company has been testing some of the enhanced LEM functionality its provider will have in its next product-line update.
“Pricing to motivate longer leases is not always the best way to set rates. Lease terms must be based on the best expiration date to maximize revenue.”
LEM calculations include how many units a property is able to turn (See “How Does LEM Work,” On page 59). “We used to budget for no more than 10 percent expiration in any month, but if we have the crews to turn units and our LRO system forecasts a high demand season, there is no reason to artificially limit the number of renewals in a normal environment,” Rogers says.
“The LEM enhancements to LRO have also allowed us to build a lease-expiration model that the system will follow to accommodate academic calendars or to correct historic build-up of leases in lower demand periods caused by past events.”
In addition to Carmel’s test, LEM pilot projects conducted with several REITs indicated revenue lift over and above the normal 3 percent to 5 percent lift that revenue management can provide without using the enhanced LEM functionality.
“The evidence we have seen in the past months gives us confidence that automated lease expiration management is an effective tool to increase revenue,” Rogers says. “We are rolling out the new LEM capability to all our communities now.”
Bruce Barfield is President of The Rainmaker Group, a provider of revenue management and profit optimization solutions to owners and operators in the multifamily housing and gaming/hospitality industries.