Over the last few months, we at D2 have been developing and sharing insight about the state of the market and the ways that companies are managing it. As the world has lurched from crisis to crisis, we have held weekly discussions to figure out what's going on. Last week was no exception, although we focused on an area that's close to our hearts: pricing and revenue management (PRM) systems.
PRM is at its most powerful in a downturn. Operators who have strong PRM strategy and execution gain a larger-than-usual advantage over competitors who think they do. The PRM system plays a pivotal role in delivering that advantage, but downturns are not a good time to simply "trust the system." PRM systems are based on statistical models. They work well when the pattern of the near future looks like that of the recent past. However, when the market changes sharply (as it has done recently), revenue managers need to understand what their systems can and can't do.
What we're learning from this downturn
With this in mind, we asked our group of industry PRM leaders what has been working and what hasn't. Here are some of their answers:
- Our system has returned to its normal level of accuracy and is working well now that we are three months into the downturn (the early weeks required more intervention).
- Seasonality for 4-8 week pricing has been a challenge in some cases, adjusted for higher closing ratios compared to the early weeks.
- Shortening the number of Leasing Velocity (LV) weeks has helped us to be much more responsive. We did this even pre-COVID. [We are big fans of lowering this setting as low as 5 in this environment, which really makes the leasing velocity respond much more to what happened last week and much less to what happened more than 2 weeks ago. In a changing environment, it is usually better for the system to respond much more quickly.
- We've been using longer lease terms to help with expiration management in specific markets. We have been holding new lease pricing and doing flat renewals. It worked well for a while, but now we're struggling to get our reacceptance back up to normal. Operations are wanting to keep rates low to build occupancy.
- We see a lot of variance between what is in third party rent reporting and what is an LRO for teams for comps. That is a new situation for us, and we are trying to determine which is more accurate.
- Early in COVID, we extended YieldStar 3 hold days longer to give prospects time to get comfortable with moving, now we're tightening them back up. [Other operators also shared that hold times back to normal.]
- We have found that LRO's renewal move-in rate has been a good data point. Being able to sandbox, recast, review renewal batches to see how current market rates are relative to renewals is very helpful. Additionally, exporting it to include any out-of-system concessions makes for a more accurate picture of the discount premium market, which has been helpful for renewal negotiations.
Concessions or Lower Asking Rents?
When markets soften, revenue managers are faced with the dilemma of offering an "off-RMS" concession or capitulating and lowering the rents. In our most recent webinar, we talked about how sometimes it may be appropriate to do an off RMS concession to help the new leasing while protecting the backdoor. But sometimes our efforts to protect renewals mean that we end up not getting enough in the front door. It's a balancing act.
We asked our participants what they thought. Unsurprisingly, we got a range of responses. Some preferred to lower rates because they did not want operations to get used to concessions. Others noted that it was dependent on traffic, with lower rents a more effective lever of driving activity at properties that need it. The presence of concessions in a local sub-market was also a consideration.
As we asked what operators about their renewal strategies (particularly renewal increase caps), it is clear from the responses that they are being conservative on renewal increases. All respondents had renewal caps in place at 4%, with most below that. Given how well leasing is holding up in most markets, there is good reason to revisit this policy.
At the start of the recession, with the prospect of massive job loss and uncertainty in how the market would respond it made sense to be extremely conservative with renewals. We supported NMHC’s recommendation to go out with flat increases for both economic and PR reasons. With rents generally down, PRM systems are unlikely to recommend large increases, except in rare circumstances. However, operators capping increases below 8% (especially below 5%) risk leaving money on the table.
Even in recession times, if a 6% rent increase is in order because a resident is 8% below market we believe they will renew at the same rate as if you capped it at 4%. Our team has conducted numerous studies - admittedly not in recession times - that demonstrate that residents will accept the increase, provided the offer still represents a discount to new rents. Increases need to be more than 10% to see material reductions in renewal rates.
Of course, this point will be moot if Congress does not come through with additional stimulus packages after July 31st, as rents will likely fall. However, for at least the next month, we recommend caps of at least 6%, preferably 8%, rather than the 2-4% range that we heard.