Seller Concessions: how they impact real estate investing
If you have never heard the term “seller concessions” and you are investing in commercial real estate and multifamily syndication deals, and don’t know what this specific term means, we are going to break it down for you here. Property managers and sponsors can employ concessions to maintain high occupancy rates and keep multifamily properties stable and competitive in their markets or to lease-up freshly delivered or refurbished units.
It is important to understand concessions, what they are, and how they impact your return on investment (ROI) when investing in a commercial real estate deal.
We’ll go through the benefits and drawbacks of using concessions, as well as how the COVID-19 outbreak affected multifamily concessions. In 2020, concessions were being handed out frequently, in 2021 they have cut back, and we will see less concessions in 2022.
What are concessions and why are they used when syndicating deals?
Any form of promotion, discount off the standard rate, or reduction of fees at a property to encourage existing renters to renew, or potential renters begin a new lease is referred to as a concession. Concessions are more likely to be found in markets with a high number of vacancies or a large flood of new units, since property managers and sponsors utilize them as incentives to compete for tenants. The most well-known concession is providing the prospective tenants with a term of free rent in order to entice them to lease a unit. Concessions, on the other hand, don’t always come as months of free rent, waived fees for paid facilities or services at a property are another example:
- Pet Fees
- Storage Fees
- Fitness Center Fees
- Parking Fees
- Application Fees
- Laundry Fees
Concessions can be used at different times for different reasons. One way in which concessions can be used is when a multifamily property is in its first “lease-up” phase. This is when the property is working to get new tenants in, to stabilize the property and future cash flows. Concessions can also be used as a part of the marketing strategy to keep great tenants or attract new tenants to maintain a low vacancy rates and be competitive in the marketplace. For tenants, concessions are a great discount!
How concessions can impact numbers in a deal
Say you are analyzing a new sponsor and they have a low vacancy rate and have not had to lower rents or offer any discount services to tenants over the last year. On paper, they have what appear to be perfect numbers, but this sponsor offered a free month concession. Let’s go through an example.
Let’s say a sponsor and property manager extended a deal to new tenants and current tenants. Where they get one free month for starting a new lease or renewing a lease. If the apartment complex has 2% vacancy, but every tenant and a new tenant had to be offered this deal of a free month, cash flow would be reduced substantially for 1/12th of the year. This is where it becomes very important to read the T12 (the real estate term for Trailing 12 Months financials), and rent rolls before investing in a deal.
If a sponsor or prior owner has set the precedent of constantly offering free months of rent, or discounts via concessions, this impacts the bottom line and ROI on the deal. Even with a low vacancy, always look at the concessions line item in the rent roll!
Rent discounts/concessions can be an effective technique for speeding up the lease-up of new buildings or attracting and retaining tenants in existing ones. Sponsors and property managers can keep rents in line with market prices while giving tenants savings by employing concessions. Continued dependence on concessions, on the other hand, might raise asking rents, which can be examined by potential lenders or purchasers. As a result of the COVID-19 epidemic, managers wanted to minimize vacancies in multifamily properties, particularly in busy gateway cities, resulting in greater concessions, resulting in record high numbers of renewed leases. However, the increase in concessions helped to entice renters to stay put, and lease price has returned to pre-pandemic levels, which might indicate that concessions will begin to “burn off” in the coming quarters.
One big reason why rents are going up again is due to the fact that Covid restrictions are cutting back and housing demand is spiking. People have confidence in the market and demand is increasing.
Be sure to pay close attention to these details when analyzing deals. This is a common section of analysis that investors look over. This will surely be a great tool for your toolbelt when looking to investing in your next real estate syndication or multifamily fund.