The Demand Solutions Blog

They're Heckling Revenue Management Again

by Donald Davidoff | August 18, 2020

heckling-revenue-managementIn the current period of rapid change, there is no shortage of views on what it all means, and what the post-COVID world will look like. Readers of this blog will know that the D2 team is spending a lot of time understanding how multifamily is changing. This week, two articles crossed my desk that represented such opposing views, that it caused me to double-take.

The first was an excellent article by McKinsey, using examples from multiple industries (including multifamily!) to make sense of our increasingly digital and virtual world. The acceleration of this change had, amongst other things, brought organizations closer to the analytics and data that drive decision-making. I was surprised, then, to read a second article, advising multifamily operators to abandon revenue management (RM) systems!

I love a provocative viewpoint, so I was curious to read the "Open Letter to The Chicago Class A Multifamily Industry," by Aaron Galvin, CEO of Luxury Living Chicago Realty. But it did not take long before the article went off down a sadly familiar path. 

Here we go again

First, the premise: the industry's performance has been surprisingly strong over the first three and half months of the COVID-19 pandemic. Mr. Galvin credits the industry having "banned together" [sic] to share "stories, strategies and innovations" to beat the slump. Curiously, the $3 trillion of federal stimulus did not get a mention in this assessment, nor did the timing of the crisis, which started right as we went into our highest season for leasing. 

Then came the familiar part: He blames a terrible month of July, with a 12% drop year-over-year in rents at the top end of the market, on RM systems, calling out YieldStar, LRO and RENTmaximizer. There's nothing new about non-revenue managers blaming RM software for market conditions, but here are a few thoughts that Mr. Galvin's shared:

  • Multifamily has blindly adopted RM as "the panacea to an industry short on capacity, creativity, and loyalty" 

  • It doesn't make sense that principles of airline or hotel pricing can help to price apartments, given length of stay and the relative importance of deciding where to live 
  • The industry's 40-50% turnover of residents as unacceptable, and attributable to RM systems

  • Leasing associates "cannot adequately explain why deciding on a 14-month lease will save a renter $300 per month"

  • Overnight rent changes in the order of $300 are normal

  • Renewal pricing appears to ignore new lease pricing, based on the example of leasing agents trying to persuade a current resident not to move to an identical unit upstairs that is currently $500/month cheaper

  • RM systems suffer from bad data, attachment to the wrong leading indicators, like occupancy (which is a trailing indicator)

  • Nobody has thought of lease expirations as a factor in pricing decisions, with leases generally terminating in off-peak leasing months

  • His native Chicago is the most seasonal market in the US (try telling that to anyone who's worked the Boston market!)

His solution:

  • Turn off revenue management
  • Focus on lead to showing to application ratios
  • Stop offering 14-16 month leases
  • Limit inventory (to avoid overloading prospects with choice)

Let's set the record straight

I think it's great to have an open discussion about RM and best practices for choosing and operating RM systems. It is worth noting that Mr. Galvin's company specializes in lease-ups, which, as any revenue manager knows, is only one piece of a complex balancing act of demand and supply. First, let's address the fundamental misunderstandings of RM strategy and the systems he is keen to turn off: 

  1. Good operators do not blindly follow their RM systems. Humans typically accept 60-90% of the recommendations depending on which system they're using and its configuration. No operator I know leaves pricing on auto-pilot, as the article suggests.

  2. Turnover is relatively high in our industry because our resident base is transient, not because of revenue management. In fact, over the 10+ years since RM has been de rigueur for large, professionally managed operations, renewal rates have risen 3-5 points. We also advocate for smart negotiation strategies, i.e., we would never advocate forcing someone to move to a similar home to get a lower rent rather than just negotiate down to a fair market value for their current home. Note that not all operators agree with our point-of-view. Of course, that's a business strategy decision, not an RMS failure.

  3. Good RM systems help keep us from emotionally over-reacting to bad news - this has helped us over the last few months. That's certainly more persuasive than blaming RM for the July decline in Chicago while attributing the March through June success to everything except the system. As I recently wrote in these pages, RM systems outperform manual pricing to an even higher degree during downturns.

  4. Overnight rent change recommendations in the order of $300 are extremely rare in LRO, and while they are more common in other systems, those systems do allow users to set limits. If your pricing is moving too quickly too often, you need to review your parameter settings, rather than throwing the baby out with the bath water and turning off your RM system.

  5. I agree that focusing on occupancy and ignoring demand indicators like leads and leases (and their conversion ratios) is a bad idea. But guess what - we already thought of that! For example, LRO's most important metrics are availability (which, unlike occupancy, is a leading indicator), recent demand (leases and guest cards) and the lease-to-guest card ratio. It’s true that not all RMS consider guest cards but that's an opinion to assert during system selection not a reason to turn off your RMS.

  6. Automated systems stay on top of lease expiration management (LEM) daily, so my experience is that properly configured systems only prefer longer lease terms when appropriate and do an excellent job of shaping expiration months to the high season of demand. I would add that when LEM charges $300 extra for a specific lease term, it's quite easy to explain and is better-addressed by training than by turning off your RMS.

  7. I agree that Chicago had too much building and that many websites overwhelm prospects with too much inventory (also sending the subconscious signal that it's a renters' market). But the former is a development strategy decision and the latter a marketing choice. Neith is a pricing issue, so it's hard to see how turning off your RMS would help!

Time to get real

The real reasons for our current situation are obvious. We have the worst economic conditions in the past 80 years, one which econometricians are likely to eventually declare is a depression rather than a recession. On top of that is a health crisis that is driving people away from urban core locations to suburban locations. While luxury apartment buildings in downtown Chicago are suffering 12% YOY declines, I've seen single-family rental data from suburbs (particularly secondary markets) suggesting YOY increases as high as 9+%.

With overall demand lower than overall supply (exacerbated by developer's decisions over the past several years), this results in a classic prisoner's dilemma. All operators would be better off limiting their rent reductions; however, should one operator lower their rents while the others don't, then that operator would outperform. The result can be a race to the bottom that is not good for anyone, but the fear of missing out coupled with laws prohibiting collusion make this the most likely outcome.

The notion that turning off RMSs is the solution is a strawman. It presumes that humans making manual decisions will be better. However, based on decades of interviews and interactions with operators, I can say with near certainty that they will focus equally or more on competitor rents and will be subject to the same or greater pressures from the prisoner's dilemma. 

We know this because most RM systems allow users to define pricing floors. Therefore, rents never go below a number that operators ultimately decide. Setting rents manually wouldn't change this dynamic. In fact, it would likely be worse as humans reduce prices "across the board", while RMSs do so selectively by unit type and floorplan only where needed.

It is not unusual that downturns cause people to see or question things they didn't notice or didn't act upon in good times. The 10-year bull market has covered a multitude of sins. As Warren Buffet has said many times, "You only find out who is swimming naked when the tide goes out!"

Finally, two thoughts that summarize the rational response to a provocative article:

  1. As I first heard from Terry Considine (CEO at Aimco) back in 2001, "Don't let perfection be the enemy of the good." RMSs are not perfect, but neither are humans. How, as the critics ask, can RM principles work in long length of stay industries such as ours? By using demand signals, supply signals and math to bring more discipline, transparency and courage to pricing than would happen without them.

  2. Good craftsmen never blame their tools. Like a chainsaw, RMSs can be used to cut down the largest metaphorical trees…or they can sever a limb. The fault in the latter case lies with the operator, not the tool.
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