by Donald Davidoff | Dec 5, 2016 12:00:00 AM
Over the last couple of months, we’ve seen increasing evidence that the historically strong “bull market” in the multifamily industry is at or nearing its end. In January this year, I wrote a post aiming to identify where we likely were in the cycle. I concluded that we were anywhere between the “5th to 8th inning” of the cycle.
Recent data from Axiometrics would indicate we’re likely in the 8th inning. Their report showed that U.S. rent growth has slowed to 3% in the third quarter (down from 5.2% a year earlier). While that still remains above the historical long-term average of about 2%, it’s a trend worth noting, particularly given the steepness of the decline from the peak.
The report shows that rent increases have been slowing for four consecutive quarters and key, traditionally strong markets like San Francisco, New York and Houston are seeing negative rent growth.
Does this mean we’re heading to a big crash, or just a return to normalcy (rent growth closer to 2%)? The answer is that we’ll have to wait and see. What is clear is that markets are softening, supply continues to increase and we need to be prepared to compete in what will be, at the least, tougher environments than we’ve experienced in more than half a decade.
The more valuable question to focus on is what actions should we take to maintain strength regardless of the greater market? Here are the five things we recommend:
Prepare Your Team
Given the unusually long bull market we’ve been in, it’s likely that a very small percentage of our leasing associates have seen a soft market and an even smaller percentage has experienced one in our company. The vast majority of them have never seen anything other than a market where operators get to set demands, raise prices and not have to worry too much about filling vacancies.
Many people on management teams haven’t been in (or don’t remember) a market where beating plan was anything but a foregone conclusion. As Warren Buffet likes to say, “It’s only when the tide goes out that you see who was swimming naked.”
The actions our people take are more important in difficult markets than they are in strong ones. We need to be sure our teams understand the dynamics of a difficult market, teach them how to adjust and be sure we are tracking the right metrics and focusing on the important actions that drive real results.
Burnish Sales Performance
Selling is always important, but in markets like we’ve experienced over the last 7+ years, poor selling - and poor selling systems - have not been punished. The likelihood is that they soon will, and I’ve got to share that based upon the conversations and reviews I’ve had with multiple operators of different sizes, segments and geographies. There is a significant percentage that isn’t ready. Our sales associates have been able to get away with being “order takers” more than salespeople, and most of us are not prepared to navigate the transition away from that.
To put it bluntly, if you haven’t significantly adjusted your approach to sales, sales training, shops and sales management in the last five years, then now is the time to get moving. Your current and future residents have changed how they learn, shop and buy; and if you want to maintain strong results in the future, your approach to sales needs to keep up.
(Re)Focus on Renewals
Renewals are typically more than half the rent roll, so they are always an important driver of revenue. However, in growth markets, we typically give residents a slight discount to market. The result is that we get greater revenue growth from new leases than from renewals. In these market conditions, we can actually have “too high” a renewal rate.
The arithmetic flips in down markets. When expiring rents are higher than new rents, we lose revenue on each new move-in. However, except in the deepest of recessions, we typically can defend rent (and even get small increases) on renewals. So raising the percentage of residents renewing directly leads to better performance.
One challenge in this is that savvy residents become more demanding during downturns. More of them want to negotiate, so we need to prepare our associates to deal with these challenging conversations.
Pay Close Attention to Pricing & Parameters
Hopefully sounding more old than arrogant, I’m in the unique situation of being the only pricing practitioner in the industry who has been through two full business cycles using automated pricing software. I started using the system going into the 2002-3 recession and of course experienced the Great Recession as well.
Perhaps the most interesting observation is that, by far, our largest outperformance versus comps came during the downturns. I’ll explore the reasons for that in more detail in a future blog; for now, just recognize it has a lot to do with what I pointed out earlier in this blog--it’s easy to perform in up markets as the rising tide masks mistakes.
If you’re not currently using an automated system, then now is the time to seriously question your approach. If you rely on concessions to stimulate demand, do you end up pricing in 8.33% increments? Do you end up clinging to a price too long, only to create panic pricing? If you use terms like “fire sale” and “loss leader,” that’s a clear indication that your approach is suboptimal.
If you are using a system, does it give you control over the parameters you need to implement a different strategy for the different business conditions? And then equally (or more) importantly, are you using those levers (yet not over-using) them? A good system makes it easy to transition from seeking rent growth to defending occupancy, from being aggressive to taking a neutral and then even a very conservative stance. A lot of our work in doing pricing platform assessments for our clients ends up helping them be more nimble in making these kinds of transitions through the business cycle.
Be Ready for (Intelligent) Cost Cutting
In all likelihood your organization has added some fat since 2010. As markets continue to soften you’re going to need to trim it back. But don’t be reactive with cuts. Far too often we cut indiscriminately. Edicts that sound anything like “cut (fill in the blank) by x%” (or worse “cut everything by x%") may be effective at cutting costs; however, they’re often even more effective at cutting morale, confidence and NOI.
Cuts shouldn’t be smooth. Some things should get cut or totally eliminated while other items need to be preserved. In some cases, certain things need more investment despite (or even because of) the declining market. We shouldn’t wait until we have to cut expenses to have our plan together. Right now is the time to complete an assessment of where we’re allocating our resources, the outcomes those investments are designed to achieve, and the priority of those efforts; and to do so in a sober fashion as opposed to the pressure of being in the middle of a recession.
While bull markets are always fun (if you haven’t had fun being an operator over the last seven-plus years, you’re probably in the wrong business), it’s in the normal and difficult markets where management teams shine, and businesses gain real advantages against their competition. Taking these five actions will put you in a strong position to finish in the winners circle.