Loss to Lease is the difference between Market Rent and Effective Rent. Effective Rent is what an apartment unit is rented out for right now. Market Rent is what the owner/manager of the property thinks they can get based on other, similar apartment rents in the area (Market Rent).
There is one common mistake I see investors make when considering loss to lease or potential rental upside on a multifamily asset.
The mistake is not knowing the difference between Forced Loss to Lease and Organic Loss to Lease.
If an apartment unit is rented out for less than market rent…just raise the rent.
If the rent is actually below market, you won’t have to renovate/upgrade the apartment to get a higher rent. If you have to renovate the apartment before you raise the rents… the rent wasn’t below market, was it?
This is the difference between organic and forced loss to lease.
- Organic Loss to Lease means you can just raise the rent when a resident’s lease comes due.
- Forced Loss to Lease means you have to renovate the apartment to get higher rents.
When analyzing a deal for purchase or investment, you should always analyze the organic loss to lease and then (and only then) calculate your rent potential after renovating a unit.
- Consider the average rent on a non-renovated unit. Bring all units on the property up to that rent without adding any capital for renovations to the equation.
- Is the deal worth buying with just on the organic rent growth alone?
- Now calculate the rent growth after renovations but add in the renovation costs to your total acquisition budget.
The idea is to understand what the deal would look like if you didn’t renovate any units nor raise the rents. Is the deal worth owning as it is or not?
If a deal is only a good deal after renovating it and raising the rents… it is a riskier deal. I am not saying it’s a bad deal, I am just saying that it is riskier.
Now consider the current inflation/economic environment and add that to your calculation. If you are not successful in raising the rents, do you still have a good deal?
