Cutting Costs: What’s the Next Layer of Opportunity for Rent Increases?

By Dennis Smillie, Multifamily Solutions Inc.

The general consensus is that most apartment markets have finally turned the corner, as evidenced by the reoccurring quarter-over-quarter rent growth that has been documented by a variety of industry-related research groups. Just as important is the fact that confidence indexes on key industry trends have all rebounded from their lows of late 2008/early 2009 to reach new record highs in the last couple of quarters, and have done so in the face of limited job growth, a key driver for the apartment sector.

This renewed enthusiasm isn’t just echoing in the halls and sessions of industry conferences and meetings; it has moved mainstream in the larger news environment with media outlets running stories on the likelihood that renters will be facing “double-digit” rent increases. Their rationale is based on the significant imbalance between increased demographic demand pressure and apartment inventory that is relatively flat as the result of the self-imposed development moratorium the last downturn created.

So let’s assume that everyone is right, and happy days are here again (until we overbuild ourselves in to the next cycle). Let’s assume we are going to experience what the pundits are saying—significant rent growth is in our immediate future. Doesn’t that make rent growth the “low-hanging fruit” of this current economic cycle?

Now is the time to leverage conditions to enact a paradigm shift in how the industry underwrites risk. Simply stated, having the “upper hand” in the market for the next cycle creates a perfect opportunity to put a mandatory renter’s insurance plan into effect. Why renter’s insurance, and why now?

Resident-caused damages account for (depending on property class and the underlying demographic) $35-$60 per unit per year. When we think about these kinds of damages, everyone’s discussion gravitates to the “big” loss (typically a fire). Interestingly enough, the vast majority of resident-caused damage claims are under $2,500. They are the real NOI killers, and they add up to significant profit drain on the property.

Being able to recapture these losses through a partnership with a qualified renter’s insurance provider has huge benefits for the apartment operator.  What does “good” look like in a renter’s insurance partner? Seek out a provider that is focused on the following key program initiatives:

■ A focus on high policy penetrations—coverage;

■ Training—not just around the front end policy placement practices, but education on how to identify and submit claims (remember that most claims are below $2,500);

■ A willingness to pay claims for the “small stuff” as well as the “big stuff.”

Putting a well-managed program in place has short- and long-term benefits. In the short term, you accomplish true risk transfer—the resident’s policy (not yours) underwrites his behavior. Additionally, you reap the economic benefits of loss recapture through the claims process.

Longer term, this risk transfer has reoccurring value. First and foremost, it’s permanent! Think of it as a loss recovery annuity. As long as coverage is maintained, the operator benefits from risk transfer and loss recapture. Additionally, property and casualty underwriters are recognizing that properties with high penetration and well-structured renter’s insurance programs in place reduce the underwriter’s loss ratios, and they are beginning to have discussions about property and casualty premium discounts for these kinds of assets.

There is another factor in risk transfer that owners may intuitively understand when they stop to think about it—a risk that in the past has not been effectively quantified. A study was recently conducted by J.A. Milan and Associates of Denver. This study looked at resident-caused damage claims and the correlation between those loss incidents and the resident’s “Renter Credit Quality”—the likelihood they would financially fulfill their lease obligations.

The study utilized CoreLogic SafeRent’s empirically derived, statistically validated lease scoring model to determine and rank order lease performance risk attributes. The research identified a direct correlation between Renter Credit Quality and the likelihood of resident-caused damages and losses in two key areas: fire and theft. Water damage, interestingly enough, does not directly correlate to renter credit quality, according to the study.

Milan states, “One of the most important economic drivers in the business model of apartment managers is the people who live in their apartment homes. Attracting and retaining the right residents, reducing expenses and improving NOI requires an enterprise-wide view of the risk and opportunity multifamily residents represent with a foundation of statistically validated decisions based on empirical data.”

Assuming we don’t hit the speed bump of a “double-dip” recession, we are going to get the rent increases we seek to capture in this next up market cycle. It’s the low-hanging fruit of supply and demand. The bigger question is how we capitalize on market conditions to make fundamental changes in the way we underwrite resident risk by improving renter credit quality and transferring underwriting risk from the owner/operator to the resident’s renters insurance carrier.

Both strategies pay short- and long-term dividends. Are you having these conversations in your senior management circle? It’s worth the discussion!

Dennis Smillie is president and owner of Marietta, Ga.-based Multifamily Solutions Inc.