The Demand Solutions Blog

Should we offer and price really long lease terms?

Posted by Donald Davidoff on May 19, 2013 1:18:00 PM

So I’m at the NMHC Market Research Forum in Boston this past week to sit on a panel/workshop on revenue management. Mark Obrinsky, who heads up Market Research at NMHC and has been a good friend and colleague for roughly decade brings up an interesting question:

“(paraphrasing) So what do you think about longer lease terms? And by longer lease terms, I mean 3-, 4- or 5-year leases.” He hypothesizes that there’s a latent, older “renter by choice” demographic that could be tapped, particularly in urban markets. The theory is that these folks would choose to rent but for the fear of unknown and thus uncertain future rent increases.

I’m of the opinion that this is probably not a good idea for reasons illustrated below, but I think it’s a provocative concept worth at least discussing. In the “nay column”:

  • A long-term lease, even with rent escalators, is essentially a put option for the resident. That means we commit to a maximum price and likely take all the risk. This is particularly true since residents can relatively easily opt out of the remaining months of a lease with little to no cost—either legally but paying a pre-determined lease break fee (typically a month’s rent) or illegally by simply skipping. It tends to be difficult, if not impractical, to hold a resident to the remaining term of the lease. But maybe there is a way to structure a lease of this type so that we could hold the resident responsible?
  • If we were to offer such a lease, we’d have to put in escalators that cover anticipated inflation plus some risk factor. That would likely discourage most prospects from choosing the option as the rent would be higher than a normal 12-month lease. But maybe we could index the rest escalation to inflation? Would that make prospects comfortable that they know future increases will be “fair” and not arbitrary or would it still scare them because the increase would still be unknown? And would our owners/executives be willing to accept renewal rent growth “limited” to CPI?
  • Perhaps the biggest reason not to do this is that the demographic pool is likely to be small. Baby boomers are a VERY small percentage of today’s rental pool. But would this option release an untapped demand? And even 1-2% of our inventory tied up for several years would reduce the available supply for traditional leases thus supporting higher lease prices—particularly for those communities on formal, automated revenue management systems.

Worth an experiment or just a crazy idea? What do you think?

Topics: Revenue Management, apartment, apartment pricing, pricing and revenue management, apartment marketing