When recession seems imminent and your livelihood as a landlord is in an apparent state of limbo, it is unwise to lethargically stand by and wait for for disaster to strike, armed only with crossed fingers of hope – be proactive! Do not let your fear of worsening the situation prevent you from improving it; prepare for action, and turn the change in economic climate into opportunity. It’s simple, yet overlooked – your tools for tackling the recession are of preparation and treatment.
What are the problems?
1. Old tenants leave
2. It becomes difficult to find new tenants
3. It becomes difficult to collect rent
Solving any of the three starts with the fundamentals, and intimately knowing your operating expenses provides you with many avenues of attack. Meticulously breaking down your expected costs into category, organized by appropriate time segments (monthly) gives you an accurate idea of what expenses you can expect to incur in a given month.
You may have jumped the gun here, tediously recording expenses for years – now use the information. There are different associated costs with rental property depending on your occupancy rate. While occupied, the expenses associated with your rental property could include mortgages/loans, maintenance costs, property taxes, property management fees etc. Assume that you are 100% occupied, and calculate your total monthly expenses. Call this your total occupancy expense. Now, assume that you are operating at 100% vacancy; take it a step further and imagine that all units are recently vacated – associated costs in this scenario include expenses to restore the unit, marketing expenses to advertise the vacant property, mortgage/loan payments, maintenance costs, costs of an on site sales force etc. Let’s call this new expense figure your total vacancy expense. You can combine these hypothetical figures to provide an accurate, look at monthly real expense in most any scenario.
Multiply the percentage of occupied units by the occupancy expense, and multiply the percentage of vacant units by total vacancy expense. Next, add the figures together to find your real expense.
If 75% of your units are occupied, with 25% vacant apply the following formula:
(.75 * total occupancy expense) + (.25 * total vacancy expense) = real expense
Now, you have a grasp on what your expenses will be no matter what the rate of occupancy, and more importantly, what revenue you must generate in order to break even – a pivotal calculation as we move forward. This equation can be used in a number of different ways, including knowing your profit margin, knowing the number of units necessary to be filled in order to break even, discovering(fill in later)
This process should yield two helpful hints: 1. It is cheaper to retain old tenants as you may have seen from the higher costs associated with recently vacated units, and 2. You may be able to renegotiate some of your contracts to reduce cost. Remember, nobody wants to lose clients during recession, and any service companies you contract with may be willing to re-nogtiate in order to maintain your business. Though seemingly obvious truths, these are consistently overlooked or ignored for a number of reasons.
Let’s get started.
First, focus on retaining current tenants, and you will naturally flow into the pursuit of new ones. In a time of recession, the main reason tenants leave leased residences is price. Help solve the problem for your tenant by lowering monthly rent. Now that you have a method of calculating your total monthly expenses depending on occupancy, apply the formula to your situation and discover your degree of flexibility in terms of rent level.
Current Occupancy: 60%
Total Occupancy Expense: $10,000/month
Total Vacancy Expense: $15,000/month
(.6*$10,000) + (.4*$15,000) = $12,000
@ 20 total units, this is equal to $600/unit
Now, you know you must make $12,000/month to break even; if your occupancy rate has been steadily declining, and the decline is seemingly tied to the surrounding recession, it may be time to reduce the rent in order to prevent continued decline in occupancy. Let’s stick with our current example, charging $2000/unit/month in rent.
12 occupied @ $2000 = $24,000/month in rental revenue, subtract the $12,000/month in expenses, and you are left with another $12,000/month in profit.
This gives you $12,000/month for a cushion by which you may lower rent. If the concern is that occupancy will continually decrease, lower the rent incrementally, and observe the effect; once it seems that current occupants have decided to stay put, you may decide whether or not to attempt acquiring new tenants using the same tactic. Another way our real expense equation may help you, is bringing to light the exact number of occupied units needed to break even. Real costs, in our example, will never be higher than $15,000 (total vacancy cost), so, how many units must be rented in order to generate at least $15,000 of revenue? The answer: 7.5 units. If eight of your units are occupied in a manner that leads you to believe the tenants will not leave or stop paying as a result of the recession, than you have an added degree of comfort by which to approach your recession strategy. However, this may not be the case, and fear of falling to or below your break even figure may be continually growing. Let’s examine ways to potentially assuage these concerns by lowering rent.
“Why continue to lower rent once people have decided to stay put?? It seems doing so would only cut into my profit margin.”
Low rent is attractive to prospective renters, and decreasing profit margin may actually increase total profit by bringing in additional tenants; thus generating more cash in-flow. Let’s take a look at how this works.
Scenario 1 (above, $2000/month charge for rent)
12 of 20 units @ $2,000/month = $24,000/month in revenue
total cost = $12,000/month
240000 – 12000 = $12,000/month in profit
Scenario 2 (1800/month charged for rent)
14 of 20 units @ $1800/month = $25,200/month in revenue
Also, your total cost calculation will be different, using the same total occupancy and total vacancy costs from the example above, and changing the occupancy rate to 70% yields a real cost of $11,500/month.
So, with a monthly revenue of $25,200 ($1,500 increase), and a total cost of $11,500 ($500 decrease), you now have a total profit = $13,700/month
By lowering rent 200/month for all units, we managed to move occupancy up to 70% and increased profit by $1,700/month, and lowered the risks of non-payment and unwanted vacancy.
16 of 20 units @ 1600/month = 25,600 revenue
total cost = $11,000
In the three scenarios above, the situation with the lowest rent point actually yields the most profit. Also, while occupied, the individual units are less costly. If done properly, such a strategy could increase cash in-flow and reduce cash out-flow. Far too often, landlords or management teams are convinced of a certain rent figure, titling it the “market rate.” But all too often, these are simply figures pieced together, inclusive of all competitors in the area, or by a type of per square foot calculation that has served its purpose well in the past. However, many management teams or landlords fall victim to the notion that these calculations hold in times of recession OR that they were ever even adequate representation of “market” rate in the first place. During recession, previous mis-pricings come to light, including rent rates. Your rental community should be considered a market within a market, not simply a piece of a broader renters market, inclusive of a large geographical area. If your city’s renters market is in crises, why would you set your prices based on the city’s standards? Clearly, the “market rate” in the area has either changed or proven itself faulty. At times, the set, “market,” price is viewed in regard to prestige, and any reduction in price is directly related to a reduction in prestige. Don’t let such matters cloud your wisdom. Remember, your market rate is self-contained within your rental community/complex – find your market rate, but be careful.
Lowering rent, if done hastily, can be damaging to your enterprise, so proceed with care, paying attention to all the resulting changes in occupancy and profit. Additionally, it is wise, upon issuing the rent reduction, to legally allow yourself to restore the rent to a previous or preconceived level with sufficient notification to the tenant (make sure the tenant is aware of the situation). This gives you freedom when rental demand increases, and protects you from some unexpected change in total cost.
The example scenario simply displays how and why lowering rent may increase profits, but if the threat of continued vacancy bares more consequence than the previous example, a landlord may be in jeopardy of recording a loss on the business, i.e. if the revenue is barely higher than the total cost. In this scenario, most landlords hesitate to lower rent because doing so is counterintuitive; however, lowering the rent to the break even point may reduce the risk of a continued decline in occupancy.This conservative measure allows you to stay in business, shielding you from some pitfalls of being a landlord during a recession. Keeping the rent high runs the risk of driving more renters away, causing landlords to, at days end, lose money. A pre-emptive lowering of rent may keep the tenants on board; while you may only be breaking even, you reduce risks of losing money. After vacancy risk has subsided, landlords may focus more attention on finding other ways to increase contracts (ex. contract re-negotiations). If nothing else, your rental community is able to weather the economic storm.
Lowering rent is not a universally effective technique for a number of reasons, so it is up to you, as the landlord, to acquaint yourself with your business, and more specifically, your tenants. Who are your tenants, where are they coming from, and why are they renting? People rent for a number of reasons, and knowing the why your tenants are where they are helps you to formulate a profit maximizing strategy.
Single people, male or female, account for 49% of all renters in the U.S., married couples without children account for only 8% of U.S. renters, and those with children account for 9%. Furthermore, single parents account for 12% of renters, and 21% of renters are in a room mate scenario. Each group of people is renting for different reasons, and each, in all likelihood, will react to decreasing rent positively, but some in different ways than others. Some questions to be answered are: what is the likelihood that decreased rent will keep this person renting, how long can I anticipate this renter will stay put, what life situation is this renter in that makes him/her a renter, how risky is this renter????
Single people are solely responsible to pay the entire rent and other living expenses. Some may be students, some may be young professionals, and some may be divorcees, amongst many other possibilities. With only one income providing for living expenses, more is at risk when that person’s income declines or has the potential to decline. The person may seek a less-expensive living situation to hedge against these risks. However, there is one particularly noteworthy characteristic of student renters (even students in room mate situations).
Typically, parents are involved or aware of the students financial situation. Whether the student pays rent personally or the parents pay rent, there is still more than one pocket from which the rent could potentially come. Ex. If a student cannot afford rent on a particular month, the parent may cover the entire rent or pay whatever balance the student cannot. This makes students less risky in terms of rent non-payment, rendering a reliability atypical of recessions. For similar reasons, credit card companies continually approve student credit cards, knowing that parents will typically bail the student out of any financial distress. Furthermore, students do not rent because they lack the financial stability to own a home, and this alone sets them apart from most renters, who may rent purely because they cannot afford to do otherwise. Even students from the wealthiest of families may choose to rent. In terms of money, students are good tenants to keep during a recession.
Single parents have more at risk than do singles without children, as they may have higher living expenses resulting from their children. The risks here are two fold, inability to pay, and desire to seek less expensive alternatives; these renters are dependent on their capacity to earn a paycheck, and when that capacity dwindles, other basic essentials will take priority over rent payment, leading them to either leave or not pay. It is important to be weary of these situations, staying in contact with these renters and finding solutions to any financial problems that may arise. If these tenants are long standing occupants, it is wise to help to accommodate them (restructuring rent payments, lowering rent, giving more time etc.), as opposed bureaucratically evicting those with tardy rent payments. Recessions can be opportunities to bolster reputation, take the opportunity if feasible or desirable – don’t forget the power of word of mouth. Moreover, turning loose those who owe money guarantees than the uncollected balance will never be obtained; if the living space doesn’t seem to be easily re-occupied, than keeping the tenant around may be a good idea.
Room mate scenarios are the most fleeting of any other occupants; these renters are constantly shopping on an almost yearly basis. Accounting for 21% of all renters, these renters should be the target when trying to fill vacancies. If your units accomodate room mates, gearing marketing strategy toward these renters will likely prove to be an effective, fruitful endeavor, as well as providing a cost-efficient marketing startegy. Typically between the ages of 19 and 30, these renters are drawn in by lower rent, and you need not worry about locking a particular unit in at a low rent rate that will not be representative of market price in the future because these tenants are unlikely to live in one spot for more than 2 years. During a recession, filling yourself with room mate renters by way of low rent offerings will be a quick, easy fix that has the fewest long term consequences. Also, roommates have more pockets from which rent might be paid, so in the circumstance that one roommate is unable to pay, it is more likely that you, as a landlord, are able to collect the entire rent or at least a significant portion of it.
Families, accounting for 9%, are the most likely renters to stay put, not looking for less expensive options, when rent is lowered. As to be expected, most family renters have, or form, strong foundations in their places of residence. In this situation, be sure to incorporate a provision for a possible future rent increase or re-negotiation. These renters are less risky than single-parent families, yet still still bear more financial risk of non-payment than students, or roommate renters.s
Once you have a general feel for who your renters are or who you would like to occupy your units, you can begin your overall strategy. Knowing who to appeal to sheds light on how to advertise, maintain, and accommodate effectively. Considering what is important to your market is important to you because you can hone in on your costs by eliminating unnecessary expenses and highlighting necessary ones. Furthermore, the insight allows you to assign an appropriate rent figure to your community as opposed to arbitrarily assigning a number you begin negotiations with. If you lower rent, advertise the new number and leave it fixed. Set your number low to attract renters, and make the figure non-negotiable. In this manner, potential renters are more likely to visit to community, generating more exposure and removing the headache of negotiation. If you are willing to reduce rent via negotiation, a recession would be an appropriate time to change the advertised rent to the lowest figure you are willing to accept – be inviting to renters!
You have a grip on your expenses; you renegotiate your existing service contracts; you adjust your rent in a fashion that retains occupancy at an appropriate level; you survive the recession. Far too often rental communities struggle to stay afloat during recession because they refuse to adjust the structure by which they function. Adamantly maintaining advertised rent or charged rent, and never taking the time to renegotiate existing service contracts. This is typical for a number of reasons: fear of change, lacking awareness of associated costs, apathy from the management group, lacking communication between management and ownership, or excessive pride to name a few. Don’t let any of these tragic flaws be the root of your demise; it’s a matter of being proactive. Charge!
The Rent Lobster