A Real Estate Investor’s Guide to Rent Concessions
This post contains affiliate links, and we may earn a commission if products or services are utilized.
Rent concessions are a crucial part of multifamily investing that requires three critical skills:
Familiarity with general rental terminology, different types of concessions, and how they differ
Knowledgeable of rental concessions history at the property
Understanding the rental market and how to underwrite concessions in your proforma analysis
Understanding the history of the concession at a property is not always straightforward and can require some investigative work. Failing to account for rent loss in your proforma underwriting could lead to disappointing investment results.
Rent Concessions
Rental concessions are discounts to prospective tenants to entice them to sign a rental lease agreement. Property managers can provide renters with concessions in the form of reduced rent, free rent, waived fees, lax security deposits, or gifts. Properties struggling with a high vacancy will likely turn to concessions as an effective leasing tool to shore up occupancy.
Rental Concession Primer: Part I
This is the first article of a two-part series. Part I covers the different types of concessions, primarily discussing the consequences of upfront vs recurring rental incentives. Part II covers rental concession history and underwriting concessions in your proforma.
Contents
Effective Rents
Before getting into concessions, you must understand the importance of effective rents. In an article about loss-to-lease, I discuss how the rental picture often gets murky due to confusing rental terminology and convulsed financial reporting. It will be worth reading this article if you haven’t yet.
Effective rents are the “true” rents stripped down to their bare bones. Once you know the effective rents at a rental property, you have the complete story, and you can begin to assess the rental data and formulate an investment plan.
Effective Rents = Actual Rents - Concessions
Determining effective rents will make it much easier to underwrite rent growth when you take over the property. Without the concessions data, you have an incomplete picture of what the rents are at the property and how they are positioned in the submarket.
In the example, if a tenant signs a $1,700/month 12-month lease but with a one-month concession, the effective monthly rent is:
Actual Annual Rent = $1,700 x 12 = $20,400
Effective Annual Rent = $20,400 - $1,700 (1 free month) = $18,700
Effective Monthly Rent = $18,700 / 12 = $1,558
When doing your rent comp analysis, you must factor in concessions for the subject property and comps to determine your proforma rental assumptions. While it should seem straightforward up to this point, concessions come in various formats.
Types of Rent Concessions
Real estate investors offer rent concessions to potential new tenants and existing residents who are up for a renewal lease term in different ways. Concessions are prevalent for all multifamily asset classes, and our financial models allow you to account for concession loss in your proforma underwriting.
A murkier rental outlook could lead to a softer market where leasing incentives become the norm in a rising interest rate environment, with the Fed dedicated to quantitative tightening.
Upfront Rental Concessions
Upfront rent concessions are the most common offering. Examples include:
First Month’s Rent 50% Off
First Month’s Rent Free
Two Months’ Rent Free
The real estate investor will take a one-time loss on the unit, and the tenant will be responsible for the total rent amount as soon as the special ends.
Example: The property owner and potential tenant agree to a 12-month lease for $1,700. To entice the tenant to sign the lease and move in at the beginning of next month, the owner offered the tenant a free month of rent.
From the tenant’s perspective, the monthly payments are:
Month 1: $0
Months 2-12: $1,700
The property owner takes a $1,700 loss for one month. A simplified profit and loss statement (P&L) during the free month would look like the following:
Market Rent: $1,700
Concessions: -$1,700
Gross Rent: $0
After the month’s free rent concludes, the tenant will begin paying $1,700 monthly.
Market Rent: $1,700
Concessions: -$0
Gross Rent: $1,700
Recurring Rental Concessions
Recurring rental concessions are often presented the same way as upfront rent concessions:
First Month’s Rent 50% Off
First Month’s Rent Free
Two Months’ Rent Free
However, a recurring concession lasts the entire new lease term instead of being a temporary incentive that falls off the books after the first month. The discount is allocated over every monthly payment.
Example: Let’s use the same 12-month lease, $1,700 monthly rent, with one month free. However, this time, the concession is recurring.
From the tenant’s perspective, the monthly payments are:
Months 1-12: $1,558
$1,700 / 12 = $142
$1,700 - $142 = $1,558
The property owner takes a $142 loss each month for 12 months. A simplified monthly P&L would look like the following:
Market Rent: $1,700
Concessions: -$142
Gross Rent: $1,558
Upfront vs. Recurring Concessions
The net rental income over 12 months is identical between upfront and recurring concessions. However, it would be best to consider some significant factors between the two different rationales.
Renter Psychology
Rent increases are an important part of real estate investing. From the renter’s perspective, accepting a rental increase will be much easier if they’ve paid the full market rate. If the rental market supported a 4% rent increase over the current $1,700 rent, the monthly increase would be:
Rent Increase: $1,700 x 1.04 = $1,785
Upfront Concession: $1,785 - $1,700 = $85 monthly increase
Recurring Concession: $1,785 - $1,558 = $227 monthly increase
With an upfront concession, the tenant has been paying $1,700 for the last 11 months (after receiving one month free). An $85 increase would be much easier to swallow than a tenant paying $1,558 monthly and seeing a $227 rent bump. While the net increase is the same year-over-year, tenants with rent concessions baked into their lease term will feel much more expensive.
Property Sale Effort
If you sell your property with recurring concessions, the next ownership group will inherit this loss (for any current tenant benefiting from a discounted lease). This lost income may hurt their potential upside as their Year 1 net operating income (NOI) projection would be lower, leading to a lower cap rate that could affect the property value. If renters pay the concession upfront, you will take 100% of the loss, but the next ownership group would have a clean slate and not be subject to any future rent loss.
Lender Terms
If you are interested in refinancing, recurring concessions could affect your lending terms and impact total loan proceeds for a refinance. If you’re interested in selling your property, the buyer who inherits your concessions financing terms could also be impacted.
If you are a long-term investor with no intention to sell or refinance, you can be slightly more lenient with your concession terms. If there is any possibility of selling, it’s best not to offer recurring concessions, as it can negatively impact your residual sale value. A potential buyer may offer less due to reduced cash flow from inherited concessions that would affect their return metrics, such as the IRR and equity multiple.
Other Rental Incentives
It’s essential to keep your eye out for other rental incentives that go beyond just discounted rent.
I’ve seen concessions come in the form of:
Visa gift cards
Electronics/New appliances (I saw a flat-screen TV concession for a new construction lease-up)
Reduced security deposits
Waived admin fees/Move-in fees
Discounted parking rent
Most property owners would prefer to waive a few admin fees before committing to free rent. Usually, if you see the above types of discounts, there’s likely some rent roll softness, and substantial leasing concessions may be next in line if the vacancy rate is well above 5%.
Note: While the bullets above are definitely “incentives” and could sway a renter to live there, I generally won’t factor in these benefits when I am calculating the effective rents (unless the incentive is a cash gift card, say $500 as an example, that directly correlates with a true rental unit discount).
It’s still important to track the bullets above in the comp analysis as they are motivating factors and give you a pulse on the submarket norms.
Analyzing & Underwriting Concessions
Summarizing Rental Concessions
Rental concessions are price reductions to new and existing tenants to entice them to sign a lease. Property managers can provide renters with concessions in the form of:
Discounted Rent
Free Month(s)
Waived Admin Fees,
Minimal or Waved Security Deposits,
Gifts (cash gift cards or electronic)
High property vacancy or a soft rental market tends to be the most significant influencer of the gravity of concessions offered by ownership to renters. Knowledge of concessions history at the subject property and the overall market will help you formulate more reasonable investment expectations.
