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In commercial real estate, value is driven by the NOI (net operating income). The NOI is simply the net amount after subtracting your operating expense from your operating income, and one of the most significant ways to increase that number is by charging more rent. In this article, we’ll explain a rent premium and how to look at them when analyzing any CRE or multifamily investment opportunity.
Key Takeaways
- A rent premium is the extra amount a prospective tenant would pay for the same particular unit after it was renovated.
- A landlord would charge a rent premium simply because they provide more value or a higher quality product and living standard for a tenant. The net difference is the “rent premium”.
What is a Rent Premium?
A rent premium is the extra amount a prospective tenant would pay for the same particular unit after it was renovated. Let’s say you made significant improvements to a property and based on comparable properties, you could now charge $150 more for the same unit; the rent premium would be $150.
Why a Landlord Would be able to Charge Rent Premium
A landlord would charge a rent premium simply because they provide more value or a higher quality product and living standard for a tenant.
Let’s say you’re choosing between two units to rent, and all things were equal in terms of the area, the nearby schools, access to shopping and entertainment, and the units were the same size. But one of the units was renovated, and the other wasn’t; which unit would you expect to pay less for?
The unrenovated unit, right?
Operators who understand how property managers evaluate rental rates price the renovation lift directly into the new asking rents.
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Rent Premium Calculator
To use the rent premium calculator below, simply input the current rental rate and the new rental rate.
When you complete, click the “Calculate” button below.
Rent Premium Calculator
Disclaimer: This calculator is for illustrative purposes only. Please seek professional advice if needed.
We’ll that same reason is why you would pay more for something renovated, and below are some of the reasons and value that might be added to substantiate that rent premium:
- Updated kitchen and washrooms
- New floors, vanity, finishes, granite countertops
- New appliance package
- Washer dryer hookups
- Tech package (Amazon Alexa, smart thermostats, and keyless entry)
- And much more!
Next, let’s dive into a specific example of rent premium in a multifamily property.
Multifamily Rent Premium Example
Let’s say we have an unrenovated 750 SqFt 1 bed 1 bath unit that is currently rented for $850. After analyzing nearby rental comps in the local area, there are comparable units that are renovated and getting $1,100.
So if we renovated our units to the same standards, we should be able to get a $250 rent premium ($1,100-$850=$250) for all of our 1 bed 1 bath units. The upgrades we would need to make to be comparable and achieve our $250 rent premium would be to upgrade the flooring, countertops, cabinetry, and appliance package.
Layering in a RUBS income recovery on top of the new rent premium can stack another $30 to $50 per door of NOI alongside the renovation lift.
What Does Month-to-Month Premium Mean?
A month-to-month premium is when a tenant pays above their in-place rent to be on a month-to-month contract for their unit. For example, if they were leasing a unit for $1,000 a month on a typical 12-month lease, they might be paying $1,200 on a month-to-month lease.
This number is subject to the landlord, but for the lack of security the landlord gets for such a short lease term; they’ll ask for a premium in rent to offset the added risk. In an apartment community, a tenant would still pay rent on a month-to-month basis like in any typical lease agreement.
On acquisition, the gap between in-place rents and the new rent premium shows up as loss-to-lease in your underwriting.
Operators turning units fast to capture month-to-month premiums often debate whether refresh paint counts as a capital expense or routine maintenance for the depreciation schedule.
Frequently Asked Questions Rent Premium
What is a month-to-month contract?›
A month-to-month contract is where a tenant has a contract with the landlord to lease a particular unit for only one month at a time as opposed to a 12-month lease which is more typical for multifamily apartments. A tenant would typically pay a premium for having such a short lease.
What is a Rent Premium - Conclusion
Sources
- NMHC — Quarterly Survey of Apartment Market Conditions
- NMHC — Apartment Industry Quick Facts
- FRED — Interest Rates and Price Indexes; Multi-Family Real Estate Apartment Price Index, Level
- Census Bureau — Housing Vacancies and Homeownership (CPS/HVS)
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Daniel Di Cerbo
Daniel is the Co-Founder and Principal of Willowdale Equity, a private real estate investment firm specializing in Class B & C value-add multifamily assets across the Southeastern U.S. He has been a sponsor on over $150M of multifamily acquisitions across Georgia and Texas.
Willowdale Equity content follows strict guidelines for editorial accuracy and integrity. Learn more about our editorial guidelines.
