What is a Rent Premium in Commercial Real Estate?
This article is part of our guide on passive investing in multifamily via syndication, available here.
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.
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?
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.
Good Read: What is RUBS income in Apartments?
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.
Good Read: Is Paint Considered Maintenace or a Capital Expense?
Frequently Asked Questions Rent Premium
No, a premium refers to the additional increase a tenant would pay for whatever reason.
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
The rent premium plays a significant role in analyzing the opportunity within a commercial multifamily real estate property. That rent premium shows you where you can take the property and what value is dormant from within. If you’re interested in learning more about other real estate investing concepts and terms like the rent premium in commercial real estate, join our FREE 5-Day Passive Real Estate Investing Video Crash Course.
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