What Is Loss to Lease

What Is Loss to LeaseWhen building a pro-forma for a potential acquisition, there are certain elements that are often overlooked, one of which is Loss to Lease.  Why – because while we kinda all know what it means, most people’s understanding is very uni-dimensional and lacking in-depth perspective. Thus, let’s define the term, and consider some of the perspective…

WHAT IS LOSS TO LEASE?

See that picture above?  This is what loss to lease does to your Gross Potential Income – you think you’ve got x amount of dollars coming in, but in reality there’s much less…  Loss to lease introduces a big gap between what the potential of the income-producing asset is, and the level of actual performance…

Follow me guys – while this varies because everyone does the numbers differently, but typically there are 4 types of rental numbers that we look for as part of the underwriting process:

1. Stated Market Rent – that which the current owner thinks the rent should be.
2. Most Recent Actual Rent – the rents that the current owner had been able to achieve within the trailing 2-3 months (T2-T3).
3. Seasoned Actual Rent – the rents that people have been paying over the course of 1-2 years (T12 – T24).
4. After Repair Market Rent – the rents we think we can achieve after we do what we need to do to those units. This is the defining limitation in any income-producing transaction.

Well – keeping the above in mind, Loss to Lease is generally thought of as the difference between #2 (Most Recent Actual Rent T3) and #4 (After-repaired Market Rent), represented as a percentage. Essentially, T3 defines for us the market of the units in as is condition, and Loss to Lease is the difference between that and what we think the upgraded units will rent for.

Now – obviously there is a slight problem with that, because a lot of the rents in the building might be even lower than the T3 rents. This can represent additional and different opportunity. Let’s talk about this:

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