The Hidden Dangers Lurking in Leases
Concessions and expiration dates can create obstacles when trying to turn around a community
Construction issues and credit quality are obvious considerations new owners might miss when buying communities to reposition. Even if the residents are qualified and paying rent, their lease expirations and the concessions they are given can cause hidden issues. We cover this here in the third installment in our series on hidden pitfalls.
“One thing that is easy to miss on your rent roll is the concessions that may have been offered,” says Diane Batayeh, CEO of Village Green. “If they were given upfront, that won’t show up on a rent roll. If they are amortized over the course of the lease, they will. So, it’s important to understand first how they were given and secondly to learn when they burn off.”
Fortunately, there are ways to evaluate concessions during due diligence to help managers avoid these risks.
“My tip would be to dig deep in your rent roll to look at gross potential rent versus net rental income and then look at the delta between those two,” Batayeh says. “Understand what the loss to lease is and how much of that is comprised of concessions.”
If operators miss amortized concessions, it is possible the residents are paying far below market rate. “That makes it even more challenging to increase their rents to your post-renovation rent,” Batayeh says. “If not planned for properly, that can pose a problem with higher turnover and vacancy.”
In these situations, Batayeh recommends that operators take great care with renewals, doing things such as meeting with residents well in advance of their lease expiration to discuss the changes planned for the community and gauge their desire and financial ability to remain. It might be necessary to offer these residents a lease renewal rate that may not be as high as the market.
“You have to be strategic and conservative when planning how you are going to renew those residents when they come up,” Batayeh says.
The timing of concession burn offs is one issue, but the timing of lease expirations can be just as important.
“We have found that during takeover, a lot of the lease expirations are not being paid as much attention to as they could be,” says Wendy Dorchester, Vice President of Talent and Culture at Pegasus Residential. “With our lease expiration matrix, sometimes we find that too many leases are expiring in one month. That is creating a big challenge for the community.”
With a lot of expiring leases at the wrong time of year, many of those apartments can sit empty for a while. “I have worked for companies in the past where having more than handful of leases expire during November, December and January is not allowed,” Dorchester says. “Then, based on leasing activity, we limit other months, particularly September and October.”