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Hi ACRE:
In the Multifamily Quiz, you ask us to calculate the loss-to-lease. Isn’t the LTL the difference between the potential market rents and the actual lease rents? In the multifamily rent roll case study, I am determining the total market rent to be $394,440 and the existing Lease Rent to be $340,138. The difference between these two numbers (the loss-to-lease) would be $54,302. The LTL question has an answer of ‘around 30,000’ – what I am missing here?
Also, in forecasting LTL in a multiyear pro forma, is the best way to determine the LTL % to use to extrapolate the historic LTL % (in place rents/market rents) and carry this forward? What if you are assuming a large rent increase post-renovation, I assume the LTL would jump for a couple of years while the higher rent units are absorbed and then would normalize.
Please respond when you have a moment. Thank you!
NickHi Nick,
If you recall from course 1. The Direct Cap Method to Valuing Real Estate, the formula we used for calculating Loss-to-Lease was:
Loss-to-Lease = –([Average Market Monthly Rent Per Unit – Average Actual Monthly Rent Per Unit] x Total Occupied Units x 12 Months).
The key part here is ‘Total Occupied Units’. Loss-to-lease is meant to track the difference between actual in-place income, and the potential income were those in-place units leased at market rate. Or in other words, how much is lost (or gained) on occupied units that are leased below (or above) market.
So in this case, the total market rent of $394,440 in market rent takes into account total units, not just occupied units. When you pull out the vacant units from the market rent calculation, the resulting loss-to-lease is about $30,000.
To your second question, in forecasting LTL in a multiyear pro forma, is the best way to determine the LTL % to use to extrapolate the historic LTL % (in place rents/market rents) and carry this forward? What if you are assuming a large rent increase post-renovation, I assume the LTL would jump for a couple of years while the higher rent units are absorbed and then would normalize.
Using historical LTL is one way to forecast LTL going forward. It really depends on what you expect to happen at the property. As you mentioned, if you are assuming a large rent increase post-renovation, than the LTL will be greater as the below-market leases roll to market. Once the property has stabilized to the market rents, than the LTL will simply be a function of leases rolling to market from one year to the next.
Happy to answer any follow up questions!
Spencer
Hi Spencer – thank you for respond and this makes complete sense now. I went back and worked through the LTL concept in course 1. In the HUD subsidized housing world (my background) the concept of loss-to-lease doesn’t really apply since the contract rents that the government pays automatically increase (or decrease) each year on a fixed date vs. throughout the year on each individual lease renewal.
Cheers, Nick
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