Of all the ways an apartment building can underperform, below market rents are the most common and the most expensive. They are also the easiest to miss.
If you have owned your building for more than a few years and you have not done a formal rent survey recently, there is a real chance your tenants are paying significantly less than what the market supports today. That gap costs you money every single month. It affects your NOI, your cap rate, and ultimately what your building is worth if you ever decide to sell.
This post is going to show you how to find out where you actually stand and what your options are once you know.
Why Rents Fall Below Market in the First Place
It usually happens gradually and for completely understandable reasons.
A long term tenant has been in the unit for eight years and has always paid on time. You do not want to rock the boat so you raise their rent modestly or not at all. Meanwhile the market moves. Inflation hits. New buildings come online at higher price points and drag comparable rents up with them. Your tenant is still paying what they were paying in 2017 and you have not thought much about it because the rent is still coming in.
Multiply that across several units and suddenly you are operating a building where the gap between what you are collecting and what the market supports is tens of thousands of dollars per year. In some cases significantly more.
In Los Angeles this problem is compounded by rent control. RSO properties have strict limits on how much you can raise rents on existing tenants annually, which means the gap between controlled rents and market rents can grow very wide over time, especially on buildings that have had long term tenants for a decade or more. That gap does not disappear when you sell the building. It transfers to the buyer, which is why it affects your valuation so directly.
How to Find Out Where You Actually Stand
The first step is a rent survey. This is a comparison of what your units are currently producing against what comparable units in your submarket are renting for today.
To do it properly you need to look at actual comparable units, not just averages. Same unit size, same bedroom count, similar condition, similar location. What are those units actually leasing for right now? Not what they were leasing for last year and not what a broad market report says. What is a tenant signing a lease for today on a unit that looks like yours.
Once you have that number for each unit type in your building, you compare it against what you are actually collecting. The difference is your rent gap.
A rent gap of ten percent is worth paying attention to. A rent gap of twenty or thirty percent is a significant drag on your returns and your asset value. Anything beyond that is a major operational issue that needs a plan.
What the Rent Gap Actually Costs You
Here is why this number matters so much. In multifamily real estate, the value of your building is directly tied to the income it produces. Investors and appraisers use a cap rate to determine value, which means every dollar of additional annual income translates into real increases in what your building is worth.
A simple example. If properties in your submarket are trading at a five cap and you close a rent gap worth $30,000 per year in additional NOI, you have just added $600,000 to the value of your building. That is not a theoretical number. That is what a buyer would pay for that income stream at a five cap.
Below market rents do not just cost you monthly cash flow. They cost you equity.
What to Do About It
Once you know your rent gap, you have a few options depending on your situation and the type of building you own.
For non-rent controlled units, the path is more straightforward. When a tenancy turns over you bring the unit to market rate. You may also be able to raise rents on existing tenants to whatever the market supports with proper notice, though you should always confirm the specific rules for your property and jurisdiction before doing so.
For RSO properties in Los Angeles the situation is more nuanced. You are limited in how much you can raise rents on existing tenants each year, but there are still strategies worth knowing. Capital improvement passthroughs allow you to recover a portion of renovation costs through rent increases above the standard annual limit. Primary renovation programs allow for larger increases under specific circumstances. And when a unit does turn over you can reset that unit to market rate entirely, which is why unit turnover is such a significant event for owners of rent controlled buildings.
There is also the question of whether the rent gap changes your timeline on selling. Some owners in this situation decide the right move is to hold, work through the turnover strategically, and bring rents up over the next two to three years before going to market. Others decide the gap is wide enough that selling now at a discount to a value add buyer is still the right outcome given their circumstances. Both can be the right answer depending on your situation.
How We Help
A rent survey can be one of the components of the McCann Multifamily Stress Test. When we sit down with an owner we can pull the comparable data for their specific submarket, compare it unit by unit against what they are currently collecting, and show them exactly where the gap is and what it means for their NOI and their asset value.
From there we help them figure out what to do about it. Whether that is a hold and improve strategy, a sale, or something in between, the rent survey gives us the data we need to have a real conversation about what makes the most sense.
If you have not had that conversation about your building recently, reach out. It starts with a free session and the information you walk away with might be the most valuable thing you learn about your property this year.
