Getting Ready for the Trickiest Budget Season in a While

All things considered, the Apartment industry is performing quite well in the majority of the U.S. Even the gateway markets are indicating they are on the upward trend to business, as usual. Owners are optimistic and their thoughts of ongoing success are top-of-mind.

But – and there’s always a but – how tricky will budget season be for management companies with the possibility of rising inflation, supply chain management issues, the eviction moratorium’s fallout and the threat of natural disasters?

ResMan held a webinar “Natural Disasters, Pandemic, Recession, Inflation – How the Heck Do We Budget for 2022?” in late August, featuring its President and moderator Elizabeth Francisco along with panelists Mary Gwyn, Chief Innovator, Apartment Dynamics, High Point, N.C.; and Jennifer Triptow, Director of Analytics & Project Management, City Gate Property Group, Dallas.

The discussion covered the state of the industry, including 2022 forecasting (plus rising expenses and rent growth) and strategies for projecting revenue and occupancy. The group also shared best practices for educating owners and investors about the economic challenges they will face with budgeting for 2022.

Solid Performance in Apartments Lately

Apartments have performed strongly the past 14 months, particularly during Q2 2021. There were 197,000 apartments absorbed, a number which hasn’t been seen since the late 1990s. The average market rent increased 3.5 percent quarter-over-quarter – the kind of growth not experienced since 1Q 2020. The overall vacancy rate fell by 70 basis points to 4 percent! Moody Analytics projects the U.S. national multifamily vacancy rate to remain within 5.25 percent and 5.75 percent by year-end.

Cautiously, Francisco said, “Unlike previous economic downturns, the government stepped in with funding to support renters and their rental obligations, begging the question: to what degree is the additional funding supporting the positive trends? Will the trends continue at the same rate now that the economy and renters have to stand on their own?”

Francisco added, “Operators in the sunbelt states benefited greatly from the population migration into those markets providing significant rent growth opportunities. But, if the migration patterns shift or slow down, will we see the same levels of rent growth?  Are we setting realistic expectations going into 2022?” she asked.

Investors are excited about rent growth,” Gwyn added, “but we have to tell them about rising expenses needed to run the property, too. North Carolina, for example, is a hot market, but 20 percent rent growth is hard to envision.

It’s our job to keep our investors informed about what’s happening with expenses and evictions, supply challenges and regulatory issues that could affect performance.We’ve had about one and a half years of this, so you should have some history on forecasting how this could play out.”

Gwyn said that the No. 1 “proforma pain point” right now is supply chain management because costs are going up and contractors are overbooked so projects take longer. “You will see increased vacancy loss because of this,” she said.

Triptow urged managers to have a conversation with their clients ahead of budget season to see if their goals and strategy have changed.

“There’s so much uncertainty,” she said. “The eviction moratorium leads to restrictions and constraints on budgeting for any pie-in-the-sky numbers. We’re being more conservative on the revenue side because the contractor shortfall means that turns, renovations and capital expenditure projects will all cost more and take longer.”

Net Rental Income

“Our data reflects net new leases are consistently being singed at market rent levels. Renewal leases, on the other hand, are reflecting concessions or discounting anywhere from one percent to even ten percent,” Francisco said.

Gwyn said she was “really bullish” about 2021 with the thought that we’d be coming out of the pandemic. She said her renewal rents and rent growth were up by 10 or 11 percent, and she believes rent will continue to grow in 2022. “Unless the government steps in with something, I don’t think we’ve seen the next ‘top’ for rents yet.”

Gwyn has been pre-leasing more quickly than normal, and with higher rent rates.

“We need to remind our team, if we’re 100 percent occupied, our rents are too low,” she said. “I’ve coached our team to test the water, ‘If you get a 60-day notice, mark it up $200.’  This way, you are being aggressive, but if you can’t find a taker, you have time to drop it a bit.”

Triptow expects they will continue to see strong renewal performance because many residents are in “uncertain situations” and will want to stay put. In-place residents will renew, she said, we expect to continue offering discounts to some degree into next year.

“When you think about the possibility of a fourth or fifth wave of COVID-19, I’m having to be more conservative in my budgeting,” she said. “This way, I don’t regret anything I’ve told to the investors that doesn’t come through.”

Occupancy Projections

Occupancy forecasts are sitting in the 94 to 95 percent range, but there are lingering effects from COVID-19. Francisco pointed out the high number of month-to-month renters from 2020 who have carried over to 2021 and now into 2022, according to ResMan data.

“As confidence in the economy rises, I expect to see a return to pre-pandemic retention rates.  However, the increase in month-to-month renters over the last year and half have not been good for lease expiration management,” Francisco said. “I’m seeing some communities with as high as 25 percent of total unit count expiring in fall and winter months for both this year and already into next year.”

Triptow said month-to-month leases are always a threat to the rent roll, no matter the circumstances, “but even more so right now given all of the uncertainty,” she added. “They don’t know where they are going or what could happen next and want to hold that rent for one more month at a time.”

Triptow tells her leasing team to give these residents some stability, and to make them a good offer and use lease expiration to try to extend them by six or seven months. “This will make your lease expiration management more manageable,” she said.

Gwyn said it’s important to “hold tight” to your lease expiration schedule, even in unpredictable times. For example, “3-bedroom units that haven’t rented by the time school has started are going to be really tough to rent and your vacancy loss will rise.” She sees some owners offering an $1,800 apartment at $1,200 to $1,500 just to get it occupied.

Use lease expiration to your advantage, Gwyn said. “Most renters look for 12-month leases because they’ve been trained to do so, and our leasing teams have been trained to sell them,” she said. “They need to be trained to offer lease terms that are best for the lease expiration matrix and help renters to realize they are available.”

For example, after taking over a community with all month-to-month leases in July and August, Gwyn offered two lease expiration choices, attached “painful” month-to-month fees, and went door-to-door and marketed those choices. She said the strategy worked well.

Gwyn also recommends creating and marketing a waiting list; those who are on it can fill in for those who have to leave in October and beyond, in some cases, for those who are evicted, she said.

She cited leasing consultant Jennifer Nevitt, who advises that by keeping a waiting list for at least 10 percent of the community’s overall units, the property will always be okay when it comes to lease expirations.

Operational Expenses

“You can’t save your way to profitability for the long term,” Francisco said. “Market changes equate to marketing changes. Don’t just do what you always do. Question it and dig into what you’re spending on.”

Gwyn said that the industry learned in 2020 that you could lease well without a lot of Internet Listing Service (ILS) spend.

“So many people were stuck at home and were shopping online for apartments,” she said. “It created a lot of less-qualified leads and our teams were only addressing about 50 percent of the leads they were given because of that.”

Today, she uses “free” channels such as Instagram and Facebook to market apartments, taking advantage of the friend referrals that come with that. Facebook Marketplace is another effective and inexpensive platform to use.

She’s also using geo-targeting and the Wayz app to draw prospects.

“With geo-targeting, the technology lets us set it up so that our apartment homes show up on the prospect’s phone while they are visiting a neighboring, competing community,” Gwyn said, who added the importance of maintaining the community’s Google My Business page.

“It’s amazing how few of your competitors are doing this,” she said. “Their listings aren’t accurate and they aren’t responding to reviews posted there.”

When it comes to supply chain constraints, most of the talk has been about construction, but operational expenses are taking a hit as well, Francisco said.

“Expenses rising for materials because of supply chain management issues; this is not something new,” Triptow said. “Investors should be familiar with its continued delays and effects. We’re in a global economy so you never know when or what might shut things down again in China or abroad. We have no control over it. Budget for an aggressive cost rise in these materials.”

Investor Approval/Buy-In

The age-old question around budgeting season is figuring out how to gain approval of owners.

“Some investors just want to know when you are sending them their income checks and others (more institutional) are on a two-year pro forma and are much more focused,” Gwyn said. “If focused two years out, this is really tough when it comes to value-add properties given delays in supplies, getting contractors, timelines.”

Triptow said making her case is not an issue as long as “she comes to the table” with diligent facts and research.

“We are the experts,” she said. “We know the micro markets and what our competitors are doing. We need to show that expertise to the investors on how we can make up for revenue shortfalls. Yes, there could be some pushback, but in the end, they will always understand a fact-based case.”