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The Danger with Concessions

Digested from MultifamilyInsiders.com

If it is time to refinance your loan, giveaways may impact the borrowing vale of a community.

If you want to refinance your community, you need to understand how concessions could affect your borrowing power.

“If you find yourself wanting or needing to refi and you begin the underwriting process you will find that lenders are interested in how much income an asset is producing and how much income an asset can optimally produce,” Joe Killinger writes for Multifamily Insiders. “Concessions add an additional layer to the equation. When underwriting the net operating income of an asset, concessions are typically subtracted from the gross rental income in order to determine the net rental income, which also factors in things like vacancy and unpaid rent that is deemed ‘uncollectible.’”

Not are concessions are equal. For new and recently rehabbed communities, developers and managers often offer lease-up concessions. Marketers will also provide discounts when rents at a community or above the market.

Those concessions are not the issue.

“Lenders will have some concern when you are looking at buying or refinancing a property with rents that are in line with market competition but have on-going concessions to keep the property occupied,” Killinger writes. “They will wonder why there are ongoing concessions, and what hidden issues might be there.

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What you Need to Know About Rent Concessions

By: Joe Killinger, Multifamily Insiders

With rent concessions on the rise nationwide we need to have an understanding what giving or offering a concession can do to your property value if not handled correctly.

Let’s start with the definition of a rent concession, a concession is any “reduction in price, rent or other benefit provided to a potential tenant as an inducement to lease your property”. There are many ways to give a concession, reducing the first month’s rent, reducing rents for a contracted time or maybe even upgrades the property they are considering ie: an accent wall or upgraded appliances. Your goal should be to have all scenarios have about the same amount of rent paid. Also, if you can get a new tenant to accept an upgrade to the unit as a concession, it can be even more beneficial to you.

What you need to consider as you are offering your concessions is how do these concession affect my long term value of my investment. If you find yourself wanting/needing to refi and you begin the underwriting process you will find that lenders are interested in how much income an asset is producing and how much income an asset can optimally produce. Concessions add an additional layer to the equation. When underwriting the Net Operating Income of an asset, concessions are typically subtracted from the Gross Rental Income in order to determine the Net Rental Income — which also factors in things like vacancy and unpaid rent that’s deemed ‘uncollectible’. This may affect the borrowing power of the property, as lenders use multiples and ratios to determine the maximum loan to value.

The top 3 types of concession are- Lease-Up Concessions, Marketing Concessions and of course the old ‘Red Flag’ Concessions.

Lets start with the Red Flag Concessions: Lenders will have some concern when you are looking at buying or refinancing a property with rents that are in line with market competition but have on-going concessions to keep the property occupied. They will wonder why there are ongoing concessions, and what hidden issues might be there.

Lease-Up Concessions are defined as discounts offered in newly rehabbed or newly constructed apartment product during the lease-up phase as a means to stabilized occupancy (roughly 90%) as soon as possible. These one-time concessions are generally not of concern to lenders so long as there is strong lease-up velocity and that asking rents are well supported by the market.

Marketing Concessions: You will find these concession across all asset classes. These are often more of a marketing play in that rents at the property may be slightly above market rates. The ‘concession’ brings rates more in line with the market. These types of concessions are usually of no concern as long as they keep the rents at the market rate.

No matter what type of concession you chose be sure that it is reflected properly in your rent roll as it will make it easier for potential buyers or lenders feel comfortable with your property.