Loss to Lease
Loss to Lease
Loss to lease is a metric frequently used to financially model real estate projects and is an important concept most commonly used in multifamily underwriting. However, loss to lease can be quite confusing to understand, especially if it is your first time encountering the term loss to lease.
What is Loss to Lease?
Loss to lease (LTL) is defined as the difference between a property’s contractual lease rates and the actual market rates. Simplified, this means that LTL is the difference between what a renter actually pays to rent a unit and what the surrounding market is leasing units at. LTL is the effect of contractual lease rates trailing the actual market. For example, a renter signs a lease for $2,500 per month for twelve months. Three months into the lease, the demand for living in the area increases therefore increasing rent rates in the area. The apartment complex is now leasing the same unit for $2,650.
How to Calculate Loss to Lease
Loss to lease is calculated by subtracting the contractual lease rate from the actual market rent. Using the example previously stated above, the loss to lease would be derived by the following: $2,650 - $2,500 = $150. The LTL is $150.
How to Compensate for Loss to Lease
When compensating for loss to lease, apartment complexes can do a number of things:
Apartments can raise rents. An apartment cannot raise rents on the first day, they must raise rents over time as contracts end and are renewed. This is known as the “turning” period which occurs slowly usually over a period of many years.
Apartments can give a free first month of rent when contracts are signed. By offering a free first month, they can raise rents for the remainder of the lease. The tenant may not notice the difference because the free month is so appealing. This is also known as net effective rent.
