A.CRE

Loss-to-Lease

The difference between in-place rent (or contract rent) and market rent. The loss-to-lease concept is most often used in multifamily underwriting. Because contractual lease rates lag the actual market, the loss-to-lease metric acts to help the real estate professional forecast coming changes to actual income going forward.

Putting ‘Loss-to-Lease’ in Context

Redhawk Equity Partners, a real estate private equity firm, is evaluating the acquisition of Sooner Heights Apartments, a 120-unit Class B market-rate multifamily property located in Oklahoma City, Oklahoma. The property, built in the late 1990s, has a current occupancy rate of 95%, and in-place rents average $1,050 per unit per month, while market rents in the area are closer to $1,200 per unit per month. This creates a loss-to-lease gap of $150 per unit per month, or 12.5% below market.

The Acquisition Context

Sooner Heights Apartments represents a value-add opportunity. The property has been under the ownership of a long-term investor who has not raised rents in several years. Redhawk Equity Partners is analyzing the property with plans to acquire and reposition it by implementing interior renovations, enhancing amenities, and bringing rents up to market levels. Understanding the current loss-to-lease is a critical part of underwriting the property’s potential income.

Calculating Loss-to-Lease

The loss-to-lease can be calculated as the difference between in-place rents and market rents. For Sooner Heights Apartments, the calculation is:

  • Loss-to-Lease = (Market Rent – In-Place Rent) × Total Units
  • Market Rent: $1,200 per unit per month
  • In-Place Rent: $1,050 per unit per month
  • Difference: $150 per unit per month
  • Total Units: 120
  • Monthly Loss-to-Lease = $150 × 120 = $18,000
  • Annual Loss-to-Lease = $18,000 × 12 × 0.95 = $205,200

Potential Gross Income

Redhawk Equity Partners estimates the potential gross income at market rents, adjusted for occupancy:

  • Potential Gross Income = (Market Rent × Total Units × 12 months) × Occupancy Rate
  • Potential Gross Income = ($1,200 × 120 × 12) × 0.95 = $1,641,600

Current Gross Income

The current gross income at in-place rents is:

  • Current Gross Income = (In-Place Rent × Total Units × 12 months) × Occupancy Rate
  • Current Gross Income = ($1,050 × 120 × 12) × 0.95 = $1,436,400

Income Growth Potential

Addressing the loss-to-lease represents an income growth potential of:

  • Income Growth Potential = Potential Gross Income – Current Gross Income
  • Income Growth Potential = $1,641,600 – $1,436,400 = $205,200

Renovation Considerations

Approximately 80% of units require light renovations at an estimated cost of $8,000 per unit. The total renovation cost is:

  • Total Renovation Cost = $8,000 × 96 = $768,000

Renovations are planned over 24 months, during which lease renewals and occupancy levels will need to be carefully managed to minimize disruptions.

Conclusion

This hypothetical case study demonstrates the importance of understanding loss-to-lease in multifamily acquisitions. By addressing the $205,200 annual loss-to-lease, Redhawk Equity Partners has the opportunity to significantly increase the property’s NOI while repositioning it as a competitive Class B asset in Oklahoma City’s growing market.

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