How Loss to Lease, Rental Discounts and Vacancies are Accounted For In Multifamily Real Estate
- Noah Avery
- Mar 21
- 3 min read
Discounts:
Say the marketed rental rate is $1,500 per month.
It's winter season and there are less people leasing units
You agree to lease a unit at $1,400
If done right, the entry should be this:
Keep the market rent the same $1,500 (towards gross potential rent)
$0 change in loss to lease
$100 each month in rental discounts in the economic vacancy section
Mistakes:
Many people see the definition of loss to lease as being the difference between marketed rents and existing lease agreements. They may see a discounted rent of $100 and a loss to lease of $100 the same. The difference is how the $100 reduction per month was attained. Did the tenant pay full price for the unit when rents were lower, or did they only agree to lease a unit if they could pay less in rent. Even though the $100 reduction is the same dollar amount, the difference in how it was attained can help identify the health of the asset.
You may also see lease renewals renew at the same rental rate that they origianlly were at even if market rents have increased. Often this occurs so that the tenant keeps living there and the owner doesn't have the turnover costs. What the seller is having to do is give the tenant a discounted rent incentive; otherwise the tenant will leave. This difference needs to be accounted for as a discount to rent in economic vacancy instead of a loss to lease that was only caused by timing of market rents when the lease was signed.
The tenant who needs a discount in rent to sign the lease will likely want a discount to sign another lease agreement.
If you categorize this discount into loss to lease you'll likely never get loss to lease burn off.
The person who paid full price market rents when then were at a lower will likely renew at the new lease at full market rent.
With this tenant you will get loss to lease burn off.
Important:
One of your biggest underwriting assumptions is how much loss to lease you can burn off. This alone can determine if the deal will be successful or not. How the effective rent was acheived matters.
Loss to Lease and Vacancies:
Rents were at $1,400 for an extended time and you just decided to raise rents to $1,500 to keep up with the natural rent growth
You have 100 leases still at the $1,400 because lease agreements are 12 months and many are in the middle of that time frame
20 leases are at the new $1,500
10 units are are vacant
Here's how the accounting should be:
Gross potential rent is market rents times the total number of units
$1,500 x 130 total units = $195,000 gross potential rent for that month
Loss to Lease accounts for the occupied units at the lower rent only. It does not account for the vacant units
$1,500 - $1,400 = $100 Loss to Lease per occupied unit
$100 x 100 units at lower lease = $10,000 for that month
"Total Rental Income" = $195,000 - $10,000 = $185,000
Vacancies are a reduction in marketed rents.
10 vacant units that month x $1,500 marketed rents = $15,000 vacancy loss
"Total Adjusted Rental Income" is the actual amount collected from rental income
$185,000 - $15,000 = $160,000.
Notes:
For this example, we'll assume there is only one floor plan. If there are multiple floor plans, you would separate them out based on the marketed rents for each floor plan vs the existing lease rental amounts for that same floor plan.
There will typically be other economic vacancy items such as discounts, bad debt and down units in the same category as physical vacancy.
Loss to Lease is not an economic vacancy item. It is its own category because it's merely an accounting entry. Loss to lease also does not hold the same negative weight as economic vacancy items such as bad debt. They should not be categorized in the same category holding equal negative weight.
Remember that loss to lease only accounts for occupied units.
You can tell if a seller included rental discounts into loss to lease if there is no "Discounts" line item in the economic vacancy section on the T12