Written Posts

Why would you leave money on the table?

6 Comments 23 March 2011

On Tuesday, Eric Brown wrote a post over on the Multi-Housing News blog entitled Why Are You Poking Your Best Customers in the Eye? Eric and I don’t see eye to eye on a few things, but I believe, in general, we enjoy the banter between one another.  While I appreciate his customer first philosophy, I differ with him on his position to not increase rents for renewals.  Here’s my rebuttal to his post.  I’d encourage you to click on the link above and read his post first if you have not had an opportunity.

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Eric, while I understand your passion for the customer here, your math is flawed, and your Southwest comparison doesn’t compare apples to apples.  I have a passion for the customer as well, but I don’t think one’s price should be driven by fear of losing your customer if supply and demand factors are telling you to raise them.  If you are Wal-Mart or maybe even Southwest (that is trying to be THE low cost provider in their markets) then maybe keeping prices low is the best strategy, but that strategy really only works well for a volume driven business model anyway and doesn’t necessarily create true loyalty.  In apartments we have a finite number of units to work with, and we’re working with an annual subscription model.  As we work with within these constraints we’re typically competing to get premium prices and maximize our revenue potential.

Unfortunately, many companies over the past few years have dealt with discounted rents and numerous concessions that devalued their properties tremendously.  This isn’t a greed thing, but the time is NOW to get that value back.  As I’ve seen at our communities it really only impacts renewals at a 5% level.  Instead of 50% renewing, it’s more like 45%.  Honestly, only 5% of our residents move out because of a rent increase.  I’d like to compare my increase strategy to your strategy given some fairly conservative estimates.  Here’s my math on this:

250 unit property example

My Plan

Average increase $30 (on 100% of the units)

We’ll assume 95% occupancy average for the year (b/c times are good)

By the end of the year the monthly rental revenue will have increased by $7125

Annualized we’ll have increased our revenue by $85,500

Cap that at 8% and we’ve improved the value of the community by $1,068,750

Not too shabby!

Your Plan

Average increase $30 (on 50% of the units only)

We’ll again assume 95% occupancy avg. for the year (b/c times are good)

By the end of the year the monthly rental revenue will have increased by $3562.50

Annualized you’ll have increased your revenue by $42,750

You’ll have also saved turn costs on 5% of your turns or approx. 12 apartments for the year

Average turn cost $750/Average vacancy loss 1 month ($1,250)/Total cost $2000 per unit

Total savings for renewing extra 5% – $24,000

Total increased revenue from increases and turn savings $66,750

Cap that at 8% and you’ve improved the value of the community by $834,375

As you can see, you’ve left $234,375 of value on the table with your plan.  And I think with the current demand in the market today the $30 increase could be too conservative, and the 1 month of vacancy loss on the additional 5% is too conservative as well.

Of course, we can twist these numbers however we want.  Someone could have 10% additional turnover, you could renew at a 60% rate reducing your increase opportunity, we could get smaller increases, or we could get larger increases.  There are plenty of variables, but the current economic state of the apartment industry is definitely in our favor for pushing rents.  And many of us are proving this with new people moving in that are willing to pay more.

As I said, I also disagree with your comparison to Southwest’s bags fly free.  That could be an argument for you to include water, sewer, trash, or utilities in your rent, but comparing free bags to overall price is not apples to apples.  Southwest adjusts their prices based on supply and demand just like the rest of the airline industry.  They do an excellent job of finding ways to reduce their costs/expenses and pass those savings onto their customers.  It was an excellent play for them to not start charging for bags when everyone else was doing it, much like it can be a good a marketing strategy for an apartment community to include water or Internet service free with rent.  However, one reason bags fly free is because they don’t use Travelocity, Expedia, or other online booking services and they pass those savings to you.  Southwest’s strategy is to be THE low cost air travel provider, and they are constantly tweaking their model so they can make that happen.

From my perspective, marketing, pricing, and strategy need to constantly adjust to the market.  Because it worked yesterday, it doesn’t mean it’s necessarily a good business decision today.  I guess what I’m saying to you here is that your strategy to not increase rents on renewals is an interesting marketing tactic, but no more.  You and your company may be in a position to do that due to a number of other great marketing plays you have made and your consistently high occupancy.  But for the many property owners that have struggled with concession driven markets and reduced rents, your concept doesn’t work and would not be good business for them.  In a completely stabilized market I could see this working, just as I also believe that in a down market, if necessary, we should reduce rents for renewals (but that’s a different story).

Bottom line, each owner has a different plan for each asset, and raising rents today is likely a solid play for many of them.  While you may not see it this way, in our industry the finite number of units we have to lease is a constraint we have to work with.  To increase revenue we can reduce expenses or raise our prices.  We don’t have the option to “sell more stuff” (as you like to say), and moving the expense needle has its limits.  Because of the finite nature of our business, we make the biggest impact by increasing rents when we can.  While I believe customer service is a huge part of doing business, I believe it’s short sighted not to raise rents when the opportunity presents itself.  Your “better way” may work for you, but it’s definitely not for everyone and likely not the majority.

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