Organic and forced appreciation or rent growth is often misunderstood, or not understood at all. These two different strategies for appreciation are extremely important to track and understand before acquiring a deal, underwriting a proforma and planning your budget. Organic rent growth is uncontrolled, where forced rent growth is controllable. When I am reviewing deals, I often see that groups are underwriting huge forced appreciation on top of aggressive organic rent growth. In todays economic climate, the micro and macro organic trends tell a story that many underwriters and brokers are not calculating into their proformas.
Organic rent growth in multifamily refers to the increase in rental income derived from existing tenants within a multifamily property, without factoring in external factors such as market conditions or changes in property operations. It represents the natural, internal growth of rental rates over time as tenants renew their leases or as new leases are signed with rent increases. YOY this trend has been 3%. It has been the rule of thumb for underwriting and for property management companies to do mock, basic budget plans. A 3% organic rent growth is no longer reality in todays climate. In fact, we are at a negative organic growth in most markets and still projecting to see a possible 4% decline. Proformas need to be given special attention to year one, with a 0 to -3% decline, year two breaking at 0% and year three with the climb back to 3%.
Organic rent growth can occur due to several factors:
- Annual Rent Increases: Property owners may include annual rent escalations in lease agreements, allowing for incremental rent growth at each lease renewal. These increases are typically based on a predetermined percentage or a fixed amount.
- Market Demand: If the demand for rental properties in a particular area is high, property owners may have leverage to increase rents as tenants compete for limited housing options. This can contribute to organic rent growth as landlords adjust rental rates to align with market conditions.
- Property Improvements: Landlords may invest in property upgrades or renovations that enhance the desirability of the units. Improvements such as modernizing amenities, renovating kitchens or bathrooms, or adding new features can justify higher rental rates, resulting in organic rent growth.
- Tenant Retention: Maintaining a low tenant turnover rate can contribute to organic rent growth. Note, this is not growth from the forced remodel, but rather the natural demand for increasing class type.
- When tenants stay in a property for extended periods, landlords have the opportunity to gradually increase rents over time. By providing quality service, addressing maintenance issues promptly, and fostering a positive living environment, landlords can encourage tenants to stay and accept rent increases.
It’s important to note that organic rent growth is distinct from external factors such as changes in the local housing market, supply and demand dynamics, or economic conditions, which can also impact rental rates. Organic rent growth focuses specifically on the internal growth potential within a multifamily property.
Forced rent growth in multifamily refers to the intentional efforts made by property owners or managers to increase rental rates in a multifamily housing community beyond what would typically occur due to market forces alone or organic rent growth. It involves implementing strategies or making changes to the property or management practices to maximize rental income.
Here are some common methods used to achieve forced rent growth in multifamily properties:
- Property Improvements: Owners may invest in property upgrades, renovations, or amenities to justify higher rental rates. This could include remodeling units, enhancing common areas, adding new facilities like a gym or pool, or improving landscaping.
- Repositioning: Property repositioning involves changing the target market or positioning of the multifamily property. This can involve targeting a higher-income demographic by making upgrades and marketing the property accordingly.
- Lease Expiration Renewals: When lease agreements expire, property owners can negotiate higher rents with existing tenants or decline to renew leases for tenants who are paying below market rates. This enables them to reset rents at higher levels with new tenants.
- Rental Incentives and Fees: Property owners may introduce new fees or reduce incentives previously offered to tenants. This can include charging for parking, pet fees, or implementing a rent increase when lease terms are up for renewal.
- Market Analysis and Adjustments: Regularly analyzing local rental market conditions and adjusting rents accordingly can ensure rental rates are in line with current demand and comparable properties. This involves reviewing rental rates in the area and making adjustments as necessary to remain competitive.
As you are strategizing your forced assumptions, be cautious of where your asset sits within the sub-community. Often times, I see aggressive plans to remodel 50% of the property in one year with an assumption of obtaining 100% of those forced rent increases in the same year. If you are basing your remodel per unit price off an asset down the road that is stabilized and class A, you will not reach those same stabilized class A prices until your asset is repositioned in year 3. Work conservatively and at a gradient, while also considering the additional organic rental increase assumed within the proforma breakdown.
It’s important to note that forced rent growth strategies should be implemented within legal and ethical boundaries, adhering to local laws and regulations governing rent increases and tenant rights. All in all, do not overpay for an asset due to weak underwriting. Partner with knowledgeable players that can strategically determine solid offer prices and proformas so that you also do not get a reputation for having to re-trade within broker teams. Remember, there are a lot of sellers that are bidding on weak underwriting to save them from their loss of equity.