Rent concessions are a tool that property managers and sponsors can use to maintain strong occupancy rates and keep multifamily properties stabilized and competitive in their respective markets, or to lease up newly delivered or renovated units.
In this article we’ll explain more about the use of concessions, their advantages and potential disadvantages, and how the COVID-19 pandemic impacted multifamily concessions.
What Are Concessions and Why Are They Used in Multifamily Properties?
A concession is any type of promotion or discount off the typical rates or fees charged at a property to entice existing or prospective tenants. Markets with a high level of vacancies or a massive influx of new units are likely to feature concessions, because property managers and sponsors will use them as incentives to compete for tenants. The most commonly known concession is a period of free rent to a new tenant in order to persuade them to lease a unit. However, concessions aren’t always months of free rent. Other examples include waived fees for paid amenities or services at a property, such as:
- Parking fees
- Storage fees
- Laundry fees
- Fitness center fees
- Pet fees
- Application fees
Concessions are used at different parts of the operating cycle of properties for different reasons. During the initial lease-up phase of a new property, concessions are typically applied to accelerate leasing activity and help the property reach stabilization faster, allowing the sponsor to replace short-term debt with cheaper permanent financing. In existing properties, sponsors apply concessions as part of a marketing strategy to attract or retain good tenants and keep the property competitive in the market place. For tenants, concessions are an appealing discount.
The Pros and Cons of Rent Concessions
The main advantage of rent concessions is that they help attract tenants and fill vacancies faster. Concessions may be useful for tenant retention as well if there is a good tenant that may be considering moving. Also, rent concessions allow sponsors and property managers to avoid lowering gross rents at properties while market factors have impacted rents temporarily. This is important because after temporary market fluctuations, sponsors can continue increasing gross rents again from where they left off instead of from a reduced rate.
For example, if a tenant paying $1,500 a month on a one-year lease received a rent concession of one free month, they would pay $16,500 at the end of the year ($1,500 x 11) as opposed to $18,000. If the lease was renewed at a 4% increase and no concession, the tenant would pay $1,560 for 12 months, or $18,720.
However, if instead of one free month the rent was simply reduced (or the concession was spread per month) from $1,500 to $1,375, although the yearly total would still be the same ($16,500), when the lease is renewed at the same 4% increase, the rent would only become $1,430 ($17,160 per year) the following year. The landlord would need to increase the rent more than 13.45%, which may be challenging, to keep up with the one free month concession example as indicated in this illustration below:
Concession: One free month of rent
Year 1: $1,500 x 11 months = $16,500/year
Year 2: $1,500 + $60 (4% increase upon renewal & no concession) = $1,560 ($18,720/year)
Concession: $-125 per month
Year 1: $1,375 x 12 months = $16,500/year
Year 2: $1,375 + $55 (4% increase upon renewal & no concession) = $1,430 ($17,160/year)
A disadvantage of concessions is that giving tenants a discount runs the risk of them expecting to keep those concessions after the initial lease term. Additionally, concessions may represent a larger issue if an existing property is having trouble staying occupied for an extended period of time without them.
COVID-19’s Effect on Multifamily Rent Concessions
The COVID-19 pandemic caused heightened levels of unemployment nationwide, which affected leasing interest in the typically popular spring season. The pandemic especially impacted dense “gateway cities,” such as New York City and San Francisco, leading to decreases in occupancy rates and rent growth. As a result, 15.3% of properties in gateway cities were offering concessions in July 2020, almost double from 8% in January prior to COVID-19, according to Yardi Matrix’s recent report on concessions. By December, the percentage of properties with concessions in gateway markets decreased, but was still higher than usual at 13%. Additionally, those properties with concessions were offering almost double the value of concessions in December 2020 from what was being offered in January 2020. Around the country there are still markets with properties offering two and even three months of concessions.
Class A properties had the largest increase in concessions as a result of COVID-19, according to Yardi. More than 27% of Class A properties were offering concessions in June 2020, compared to 17.1% in January. But by December, it shrunk to 19.1%. Thanks to the concessions, Generation Z renters – many of whom moved back home when the pandemic began – returned to rentals, and many even traded up to pricier apartments that became more attainable.
Today, as there is still quite a bit of uncertainty in the economy, concession values are still at all-time highs as of February 2021, according to a report from MRI Software, a real estate software company. However, MRI’s report also showed that February lease pricing has rebounded to levels from a year prior despite elevated concessions.
Conclusion
Rent concessions can be a useful tool to accelerate lease-up schedules for new properties, or to attract and retain tenants in existing properties. By using concessions, sponsors and property managers can keep rents aligned to market rates, while tenants enjoy discounts. However, the continued reliance on concessions can inflate the asking rents of properties, which can be scrutinized by potential lenders or buyers. The COVID-19 pandemic resulted in higher vacancies in multifamily properties, especially in dense gateway markets, which lead to higher concessions. However, the increase in concessions has helped attract renters back to the market and leasing pricing has rebounded to pre-pandemic levels, which could be a sign that concessions will start to “burn off” in future quarters.