Why Evaluating Rent Is Critical Before Acquiring An Apartment Community

Our blog posts over the past couple of weeks have focused on how property management companies can evaluate apartment communities in acquisitions. As a prosperous outcome is the goal for every acquisition, we've discussed why it's important to take the time and evaluate an apartment community's marketing, leasing and management before actually buying it. 

The last—and likely most important—thing to evaluate before acquiring a property is rent. Why? Rent can shine more light on a community's operation and performance because it's a primary contributor to many other things. If that community has a higher turnover rate, it could be a rent issue. If the occupancy is consistently below target and they need to spend more on marketing at all times throughout the year, rent may be the culprit, too.

In all areas, evaluators should be looking for signals that indicate that the apartment community in the possible acquisition has been underperforming. But only after they've ascertained whether or not the rent is set correctly will they be able to know the specific things that'll need to be addressed to truly improve that community's financial situation.

In this blog, we'll show you what we believe to be the best method to evaluate rent before acquiring an apartment community. While this method requires more detailed calculations and is a longer process than other areas of evaluation, completing this rent evaluation may help you generate thousands more in revenue annually.

Video: Why Evaluating Rent Is Critical Before Acquiring An Apartment Community

1. Compare Floorplans With The Same Bedroom And Bathroom Count

Only comparing floorplans with the same bedroom count and not properly taking into account the other distinct differences is a common mistake we've seen made here. Most know, intuitively, that a 2 bed/2 bath unit is worth more than a 2 bed/1 bath unit. As such, the only way you can evaluate rent—and know whether or not that property has been undervaluing itself—is to manually compare the listed rent prices of a specific floorplan at the community with the listed rent prices of a competitor's floorplan with the same bedroom and bathroom count.

The other problem with comparing floorplans by bedroom count only is that not all square footage is equal. Oftentimes, evaluators will just assume that if there’s a 1,000 square foot unit at another property that rents for $1,000/month, or $1 per square foot, then the correct value for a 1,200 square foot unit at the property they're acquiring should be $1,200/month, and so forth. This line of thinking isn’t true when comparing rents between properties because we typically find that larger units usually will rent at a lower price per square foot. 

2. Study How Rent Is Set Based On Square Footage

In order to truly evaluate rent, you need to study and find the differences in how the rent price of competing communities gets determined based on square footage, and then use that as a standard to see whether or not the community you’re interested in acquiring is priced accurately. 

Here’s a scenario to help walk you through how to do this correctly. Let’s say we’re evaluating the rent for the 2 bedroom/2 bath floorplans at four separate communities—the one you’re interested in, which we’ll call Ocean View Apartments, and three of its competitors (Palm Tree Flats, The Landing At Bayside, and Gulf Beach Apartments). 

To start, chart out the square footage of units in that floorplan from each apartment community, as well as the current rent for each. These two numbers will eventually help you calculate both fixed rent and price per square foot. The breakdown looks like this:

Ocean View has units in this floorplan that are 725 square feet, and they’ve set their rent at $805/month. Compared to the other properties, is this the right pricing? 

The answer is no, and we’ll explain why in the next section.

3. Calculate Incremental Price Per Square Foot

First, the units for the other properties compared above incrementally grow in size, which changes the incremental pricing per square foot. You need to be able to graph out what that incremental pricing per square foot increase is between each community. 

Here’s an equation you can use to do that: 

Incremental Rent / Incremental Square Foot Growth =
Incremental Price Per Square Foot 

For example, the incremental square foot growth between the 2 bed/2 bath units at Ocean View Apartments and Palm Tree Flats is approximately 75 square feet. Meanwhile, the incremental rent increase between those two amounts to $25. This means that the incremental price per square foot between those two communities is $0.33. 

$25 / 75 Feet =
$0.33

Continue calculating the incremental price per square foot accordingly until you have these numbers:

The incremental price per square foot increase between these communities varies. There are three separate values—$0.33, $0.20, and $0.78. Now, combine those prices and calculate what the average incremental price per square foot is for the 2 bed/2 bath units between those four communities. In this case, that equals to $0.44, which is the number we’ll use going forward.

4. Determine What The Average Fixed Rent Rate Should Be (And If The Community In The Acquisition Is Charging The Right Rent)

Next, you need to determine what the average fixed rent rate is for a 2 bed/2 bath unit at the competing properties of the one you’re looking at acquiring. The way to do this is as follows: 

Current Rent - (Square Footage x Average Incremental Price Per Square Foot)
= Fixed Rent 

Here’s how that breaks down: 

The fixed rent prices for those three example communities varies slightly. This is how it will look in most cases for you as you determine the fixed rent at other properties. Here, again, we can take the average, which amounts to $517.13. 

Finally, we can apply this equation to the example property we’re looking at, Ocean View Apartments, to evaluate what its rent rate should be: 

Average Fixed Rent + (Square Footage x Average Incremental Price Per Square Foot)
= Total Rent

$517.13 + (725 x $0.44) =
$836.13 

As it turns out, Ocean View Apartments is actually undervaluing itself because it’s current rent is $805 but it should be somewhere between the range of $835- $840. This indicates that you, the potential buyer, could feel safe about raising rent if you acquire the property and, thus, improve the financial situation overall. 

Think about how much of a difference $30/unit each month could make. If Ocean View has 50 2 bed/2 bath units on its property, that amounts to an additional $1,500 of rent revenue per month, or $18,000/year. Since this would all be profit, a 5% cap rate would add $360,000 to your property value! 

In a different scenario where the 2 bed/2 bath at Ocean View was priced much higher, you could do the exact same math above and learn that Ocean View Apartments was overvaluing itself. Perhaps Ocean View is struggling because competitor rent levels are more appropriate and, thus, are a more affordable and attractive option for most of Ocean View’s prospective residents. 

The point here is that when you’re evaluating rent, take the time to do some of this detailed math to know whether or not the property you’re interested in acquiring is priced accurately. Don’t assume that all square footage is created equal, when it’s not. Doing the math outlined above will help you evaluate the rent price situation you’d be acquiring and the revenue opportunities it may or may not offer. 

For more insights like this on apartment community acquisitions, download and read our ebook The Complete Guide To A Multifamily Property Management Transition by filling out the form below.