How to Approach Renewal Trade-Outs This Fall
by Donald Davidoff | September 01, 2020
As we begin to enter a lower season while still dealing with the effects of the COVID-19 pandemic and concomitant recession, we thought it would be a good idea to take some time and focus on renewals.
With new rents declining in new markets even during this past summer and thus almost sure to decline more at least until next spring, renewals and renewal rents are even more important than ever. So when is it ok to keep renewal increases flat versus giving minimums? And are there times where we would actively offer rent decreases in our renewal offers?
In normal times, most operators implement a 1-2% minimum increase. At the start of the recession, most operators went to flat renewals. But now that we’re almost six months into the recession, what should we do?
As with most strategy questions, there is no one single, “right” answer. The choice depends on owners’ objectives, operating culture and sensibilities around where rents are likely to go. That said, here’s what D2 Demand is recommending to its clients.
The case for renewal increases
If you haven’t done so already, we do recommend going back to renewal rent increases where market conditions justify them. In past recessions, renewal rents outperform new rents; however, this time, early renewal rent freezes, coupled with the surprising maintenance of demand in many secondary and tertiary markets resulted in the reverse. Most operators we know have gone back to renewal increases, albeit often with lower caps than before. We strongly support that approach
However, many markets are now “inverted” (meaning expiring rents are higher than new lease rents for the same home. Add to that upcoming lower seasonality, and we expect more of these situations in the near future. Our preferred strategy is to go with no less than a flat renewal (i.e., set minimum increases to 0%), especially in markets with modest inversion, and then negotiate when necessary. This helps reduce the number of rent reductions while still protecting the back door.
A key part of this strategy is creating flexibility by allowing negotiations when the situation warrants it. In our experience, there are many operators who follow this approach, and many who still do not allow negotiations. Often the issue of “fair housing” comes up. That subject is beyond the scope of this blog but suffice it to say that I ran pricing at Archstone with this approach in place for ten years and through 2 recessions with nary a renewal fair housing issue that ever came to my attention. To do it, you need a well-stated, consistent policy; training for whoever handles renewals on how to discuss and negotiate offers appropriately; and tools to help manage the discussion. This strategy aims to ensure that we never lose a renewal only to replace it with a new resident at a lower rent than what our final offer to the current resident was. Anyone who would like to learn more is encouraged to contact us.
You can tell this approach is working well, when a) some renewals are at the offered amount, and b) not all negotiated renewals are negotiated to the minimum allowed.
How to mitigate potential risk
If you find few or no residents accepting offered rents or anecdotes of residents who are so upset with the offer that they don’t even contact you to negotiate, then it’s time to consider the worst-case scenario of actually sending out offers with a rent reduction. A quick aside: you can discover this by a) ensuring every resident sending in an NTV gets called immediately and b) monitoring social media and ratings reviews.
This situation is rare but did happen for a few months in the Great Recession in places like New York and Seattle that had massive rent declines and savvy residents with many options. It was based entirely on the size of the inversion and residents’ behavior, not on seasonality or other factors.
Another scenario justifying rent declines in offered renewal rents is when residents are coming off short-term (or MTM) rents and renewing on a long-term lease. These tend to be very rare, and I mention them only for completeness. If someone is paying a premium for a short-term lease and then is willing to move to a long-term lease, it seems unwise to risk losing them to maintain a premium you would not get were they leasing long term the first time.
Follow this advice when you have rent inversion, and your renewal rents (even if lower than expiring rents) will be, on average, higher than your new lease rents and thus help defend (though not necessarily increase) your rent roll. Call us if you’d like to hear about how we’ve worked with clients to create renewal training programs (particularly how to handle renewal negotiations), policy or strategy improvements and renewal workbenches.