"Loss to Lease" in real estate is a term used primarily in the context of property management and investment, particularly in multifamily and commercial real estate. It refers to the difference between the actual rent being paid by tenants and the potential rent that could be obtained at current market rates. It could be positive or negative and yes I've seen situations where the existing rent is more than the market rents. It means there is less opportunity to improve rents.
I've built many real estate models and worked on countless more for clients over the years.
Here’s how it typically works:
Market Rent: This is the amount that could potentially be charged for a rental unit, based on current market conditions. It’s essentially what similar units in the area are renting for.
Actual Rent: This is the rent that tenants are currently paying, which might be lower than the market rent due to various reasons such as long-term leases signed in the past or incentives offered to tenants.
Loss to Lease represents the revenue loss due to this difference, indicating how much more income the property could generate if all units were rented at market rates. It is an important metric for property owners and managers because it helps assess the effectiveness of their leasing strategies and understand the potential for revenue growth.
For example, if a unit could be rented for $1,200 based on current market conditions, but is only rented for $1,100, the loss to lease for that unit would be $100 per month (reduction of potential rent). If the unit could be rented for $1,200 and is currently rented for $1,300, then you have a $100 per month positive loss-to-lease. This means in the pro forma your LTL row would be increasing gross rental income rather than decreasing it.
Sometimes you may see an LTL premium or Renovation premium to show the amount per unit that will change based on those metrics in comparison to existing rents.
Modeling this can be tricky because you will need some sort of way to show how LTL will change over time as rents are planned to eventually get closer to the market rent if you are starting below market rent. I typically have users begin with the expected pro forma rent per unit (what the acquirer plans to charge for rents on day 1), and have a % increase over time that simulates the idea of starting at a certain rent and then going up from there rather than trying to predict the gap closing with LTL and the market rents.
The above style bakes in renovation premium and LTL premium into a single expected starting rent per unit rather than trying to compare what you are going to charge with the market/existing in order to come up with the right rental income on the pro forma. In the end, both get you to some number that should be close, but it is a matter of complexity.
The most important thing the model can do is give an idea of the expected cash flow generated from the property. As long as what you are modeling is doing a good job at that, per the assumptions, you are ok.
In one of the more robust apartment complex acquisition models I have (also good for self-storage and multifamily) there is a rent roll section in there that compares the market rent to pro forma rents and existing rents. This lets the acquirer have an idea of how far off they are from market rents if at all.
I also don't typically have a T12 drop-in because this is hard to make ready for all the different exports that people get, so the models will have sections to simply enter operating expenses over time.
One simple model that has loss-to-lease in it is this multifamily real estate model.
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